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 $70.

Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $42,000 a year to inspect the CD players. An average of 2,200 units turn out to be defective - 1,760 of them are detected in the inspection process and are repaired for $80. 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 $190,000. The machine would last for five years and would have salvage value at that time of $22,000. Brisbane would also spend $450,000 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 400 per year. 330 of these defective units would be detected and repaired at a cost of $43 per unit. Customers who still received defective players would be given a refund equal to 120% of the purchase price.

Questions 1 & 2
1. What is the Year 3 cash flow if Brisbane keeps using its current system?
2. What is the Year 3 cash flow if Brisbane replaces its current system?

Questions 3 & 4
[NOTE: When computing present values, use the present value factors from the tables on page 118 in the Coursepack]
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

1) Year 3 Cash flow if Brisbane Keeps using its current system would be 182800 $

2) Year 3 cash flow if Brisbane replaces its current system would be 64337 $

3) Assuming a discount rate of 8%, what is the net present value if Brisbane keeps using its current system : 729867 $

4)Assuming a discount rate of 8%, what is the net present value if Brisbane replaces its current system: 948620 $

Workings for Answer 1 & 3 is as follows

Figures in $		YEAR 0	YEAR 1	YEAR 2	YEAR 3	YEAR 4	YEAR 5
	Rate	0	1	2	3	4	5
Vol (units)
Defective			2200	2200	2200	2200	2200
Stage of Detection
Inspection			1760	1760	1760	1760	1760
Customer			440	440	440	440	440
			2200	2200	2200	2200	2200
Inspection cost	Per annum		42000	42000	42000	42000	42000
Repair cost/unit at inspection stage	80		1,40,800	1,40,800	1,40,800	1,40,800	1,40,800
Sales return @ sale price			89,760	89,760	89,760	89,760	89,760
Sale/unit			204	204	204	204	204
Cost/unit			134	134	134	134	134
Contribution/unit			70	70	70	70	70
Current system
Cash flow
Inspection cost			-42000	-42000	-42000	-42000	-42000
Repair cost			-1,40,800	-1,40,800	-1,40,800	-1,40,800	-1,40,800
			-1,82,800	-1,82,800	-1,82,800	-1,82,800	-1,82,800
PV	8%		0.93	0.86	0.79	0.74	0.68
			-1,69,259	-1,56,722	-1,45,113	-1,34,363	-1,24,411
Total		-7,29,867

Workings for Answer 2 & 4

Figures in $		YEAR 0	YEAR 1	YEAR 2	YEAR 3	YEAR 4	YEAR 5
	Rate	0	1	2	3	4	5
Revised after changing system
Vol (units)			400	400	400	400	400
Inspection			330	330	330	330	330
Refund			70	70	70	70	70
Repair cost	43		14190	14190	14190	14190	14190
Excess Refund (120% of sale price -Sale price)	40.8		2856	2856	2856	2856	2856
New system
Cash flow
Capex
X Ray Machine		-190000					22000
Training cost		-450000
Revised inspection cost	64000 per annum		-64000	-64000	-64000	-64000	-64000
Revised repair cost	43/unit		-14190	-14190	-14190	-14190	-14190
Excess refund cost	20% above sale price		-2856	-2856	-2856	-2856	-2856
		-640000	-81046	-81046	-81046	-81046	-59046
PV	8%	1	0.93	0.86	0.79	0.74	0.68
		-6,40,000	-75,043	-69,484	-64,337	-59,571	-40,186
Total		-9,48,620