Question

The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $199 with a resulting contribution margin of $79.

Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $40,500 a year to inspect the CD players. An average of 2,100 units turn out to be defective - 1,470 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 five years and would have salvage value at that time of $21,000. Brisbane would also spend $460,000 immediately to train workers to better detect and repair defective units. Annual inspection costs would increase by $24,000. This new control system would reduce the number of defective units to 400 per year. 335 of these defective units would be detected and repaired at a cost of $41 per unit. Customers who still received defective players would be given a refund equal to 120% of the purchase price.
1. What is the Year 2 cash flow if Brisbane keeps using its current system?  
2. What is the Year 2 cash flow if Brisbane replaces its current system?  

[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 6%, what is the net present value if Brisbane keeps using its current system?  

4. Assuming a discount rate of 6%, what is the net present value if Brisbane replaces its current system?

Answer 1

Current System Selling Price Contribution margin $ 199 $79 Cost of X ray Machine machine life salvage value One time training cost Annual Inspection No. of defective Unit Detected remaining full refund would be given @ $196*120% Proposed 200000 5 Year 21000 460000 40500+24000 64500 400 335 Repairing cost of 335 $ 41 65 Inspection cost Defective Items Detected remaining full refund would be given @ $196 40500 2100 1470 Repairing cost of 1470 $85 630 Answer -1 Assume sales quantity (As sales Details is not provided in Question) 10000 units Answer - 3 Contribution inflow Inspection Cost Defected item repair cost replacement cost Cash Flow 7,90,000 (10000*79) -40,500 -1,24,950 1470*85 -1,25,370 630*199 4,99,180 Discount Rate Cash Flow PV at Year 0 6% 4,99,180 4,44,268.42 Answer -4 Discount Rate Cash Flow PV at Year 0 6% 36,243 32,256.14 Answer -2 Assume sales quantity Contribution inflow Cost of X ray machine One time training cost Annual Inspection Defected item repair cost replacement cost Cash Flow 10000 units 7,90,000 (10000*769) -200000 -460000 -64500 40500+24000 -13735 335*41 -1552265*199*120% 36,243