Question

The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $204 with a resulting contribution margin of $80. Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $38,500 a year to inspect the CD players. An average of 1,900 units turn out to be defective - 1,330 of them are detected in the inspection process and are repaired for $85. If a defective CD player is not identified in the inspection process, the customer who receives it is given a full refund of the purchase price. The proposed quality control system involves the purchase of an x-ray machine for $200,000. The machine would last for four years and would have salvage value at that time of $22,000. Brisbane would also spend $470,000 immediately to train workers to better detect and repair defective units. Annual inspection costs would increase by $22,000. This new control system would reduce the number of defective units to 390 per year. 330 of these defective units would be detected and repaired at a cost of $48 per unit. Customers who still received defective players would be given a refund equal to 120% of the purchase price.

3. Assuming a discount rate of 8%, what is the net present value if Brisbane keeps using its current system?

4. Assuming a discount rate of 8%, what is the net present value if Brisbane replaces its current system?

Answer 1

Initial Investment	Amount in $
	Current	Proposed
X Ray Machine Purchase - Outflow	-	-2,00,000
Training of Employees	-	-4,70,000
TOTAL INITIAL INVESTMENT	-	-6,70,000

	Annual Cash Flows ( in $)	Current	Annual Cash Flows ( in $)	Proposed
		Year 1-4		Year 1-4
1	Inspect CD Player	-38,500	Inspect CD Player ( 38500 + 22000)	-60,500
2	Repairing Cost (1330*85)	-1,13,050	Repairing Cost (330*48)	-15,840
3	Refund Cost ( 1900-1330)* $204	-1,16,280	Refund Cost ( 390-360)* ($204*120%)	-14,688
	Annual Cashflow	-2,67,830	Annual Cashflow	-91,028

Tax Benefit of depreciation is not provided so it is assumed to be NIL.

Terminal Cash flow	Amount in $
	Current	Proposed
Scrap Value of Machine	-	22,000
Total	-	22,000

CURRENT
Year	Net Cashflow (A)	Formula for PV Factor	PV Factor @8.00%	Amount in $
0	-	1	1	-
1	-2,67,830	1/1.08	0.9259	-2,47,991
2	-2,67,830	1/1.08^2	0.8573	-2,29,621
3	-2,67,830	1/1.08^3	0.7938	-2,12,612
4	-2,67,830	1/1.08^4	0.7350	-1,96,863
4	-	1/1.08^4	0.7350	-
NET PRESENT VALUE				-8,87,087

PROPOSED
Year	Net Cashflow (A)	Formula for PV Factor	PV Factor @8.00%	Amount in $
0	-6,70,000	1	1	-6,70,000
1	-91,028	1/1.08	0.9259	-84,285
2	-91,028	1/1.08^2	0.8573	-78,042
3	-91,028	1/1.08^3	0.7938	-72,261
4	-91,028	1/1.08^4	0.7350	-66,908
4	22,000	1/1.08^4	0.7350	16,171
NET PRESENT VALUE				-9,55,326