Question

Verizon Manufacturing Company spent $400,000 in 2016 to inspect incoming components. Of the $400,000, $240,000 is fixed appraisal costs. The variable inspection cost is $0.20 per component. It takes two components for each finished product. Internal failure costs average $80 per failed unit of finished goods. In 2016, five percent of all completed items had to be reworked. External failure costs average $200 per failed unit. The company's average external failures are one percent of units sold. The company manufactures all units as ordered and carries no materials inventories. Seeking to decrease its total cost of quality (COQ), Verizon contracted Quality-is-Free Consultants, Inc. (QIFC) to study ways to improve product quality and to reduce costs. Upon completion of the study, QIFC recommended automatic inspection equipment that requires a $60,000 annual cost for training and $150,000 for equipment rental and maintenance. The new equipment will eliminate $40,000 of the fixed appraisal costs, reduce the amount of unacceptable product units in the manufacturing process by 10 percent, and cut product failures by half. The company paid the consulting firm $100,000 in early January 2017 for the project. Verizon expects no changes in its operating level in the foreseeable future. What is the current 2016 total cost of Quality (COQ)? $5,200,000. $2,400,000. $400,000 $2,800,000. $1,600,000.

Answer 1

$2,800,000 is the correct option.

Total cost of quality=Current total inspection cost+internal failure cost+external failure cost

First we would calculate number of units manufactured:

Current total inspection cost=$400,000

Revised variable cost of inspection=Total cost-fixed cost=$400,000-$240,000=$160,000

number of components used=Revised Variable cost of inspection/ per unit variable inspection cost

number of components used=$160,000/0.20=800,000

number of units manufactured=800,000/2 components=400,000

Now, we would compute the internal failure cost and external failure cost

internal failure cost in 2016=number of units manufactured*rework%*internal failure cost per failed unit

internal failure cost in 2016=400,000*5%*$80=1,600,000

external failure cost in 2016=number of units manufactured*rework%*external failure cost per failed unit

external failure cost in 2016=400,000*1%*200=800,000

Thus, Total cost of quality 2016=$400,000+1,600,000+800,000

Thus, Total cost of quality 2016=$2,800,000