Relevant Costs and Quality Improvement; Chapter 12 Each year, Worrix Corporation manufactures and sells 3,000 premium-quality multimedia projectors at $12,000 per unit. At the currentproduction level, the firm’s manufacturing costs include variable costs of $2,500 per unit and annualfixed costs of $6,000,000. Selling, administrative, and other expenses (not including 15% sales commissions) are $10,000,000 per year.[LO 17-1, 17-2, 17-6][LO 17-2, 17-5, 17-6][LO 17-1, 17-217-5, 17-6]Final PDF to printerblo17029_ch17_713-774.indd 767 02/19/18 09:10 AMChapter 17 The Management and Control of Quality 767The new model, introduced a year ago, has experienced a flickering problem. On average, thefirm reworks 40% of the completed units and still has to repair under warranty 15% of the unitsshipped. The additional work required for rework and repair caused the firm to add additional capacity with annual fixed costs of $1,800,000. The variable costs per unit are $2,000 for rework and$2,500, including transportation cost, for repair.The chief engineer, Patti Mehandra, has proposed a modified manufacturing process that willalmost entirely eliminate the flickering problem. The new process will require $12,000,000 for newequipment (including installation cost) and $3,000,000 for training. The firm currently inspects allunits before shipment. Patti believes that current appraisal costs of $600,000 per year and $50 perunit can be eliminated within 1 year after the installation of the new process. Furthermore, if thenew investment is made, warranty repair cost per unit are estimated to be only $1,000, for no morethan 5% of the units shipped.Worrix believes that none of the fixed costs of rework or repair can be saved and that a newmodel will be introduced in 3 years. This new technology would most likely render obsolete theequipment the company purchased a year ago.The accountant estimates that warranty repairs now cause the firm to lose 20% of its potentialbusiness.Required1. What is the total required initial investment cost (cash outlay) associated with the new manufacturingprocess?2. What is the total expected change (i.e., increase or decrease) in cost of quality over the next 3 years fromusing the new manufacturing process being proposed?3. Based solely on financial considerations, should Worrix invest in the new process? Specifically:(a) What is the cumulative (i.e., 3-year) estimated change in pretax cash flow assuming the new systemis implemented? (b) What is the estimated payback period for the proposed investment (see Chapter12)? (c) What is the estimated pretax internal rate of return (IRR) (to 2 decimal places) for the proposedinvestment? (Use the built-in IRR function in Excel to answer this question.)4. What additional factors should be considered before making the final decision?5. A member of the company’s board of directors is very concerned about the substantial amount of additional funds needed for the new process. Because the current model will be replaced in about 3 years,the board member suggests that the firm should take no action and the problem will go away in 3 years.Do you agree? Why or why not?
Relevant Costs and Quality Improvement; Chapter 12 Each year, Worrix Corporation manufactures and sells 3,000 premium-quality multimedia projectors at $12,000 per unit. At the current
production level, the firm’s
fixed costs of $6,000,000. Selling, administrative, and other expenses (not including 15% sales commissions) are $10,000,000 per year.
[LO 17-1, 17-2, 17-6]
[LO 17-2, 17-5, 17-6]
[LO 17-1, 17-2
17-5, 17-6]
Final PDF to printer
blo17029_ch17_713-774.indd 767 02/19/18 09:10 AM
Chapter 17 The Management and Control of Quality 767
The new model, introduced a year ago, has experienced a flickering problem. On average, the
firm reworks 40% of the completed units and still has to repair under warranty 15% of the units
shipped. The additional work required for rework and repair caused the firm to add additional capacity with annual fixed costs of $1,800,000. The variable costs per unit are $2,000 for rework and
$2,500, including transportation cost, for repair.
The chief engineer, Patti Mehandra, has proposed a modified manufacturing process that will
almost entirely eliminate the flickering problem. The new process will require $12,000,000 for new
equipment (including installation cost) and $3,000,000 for training. The firm currently inspects all
units before shipment. Patti believes that current appraisal costs of $600,000 per year and $50 per
unit can be eliminated within 1 year after the installation of the new process. Furthermore, if the
new investment is made, warranty repair cost per unit are estimated to be only $1,000, for no more
than 5% of the units shipped.
Worrix believes that none of the fixed costs of rework or repair can be saved and that a new
model will be introduced in 3 years. This new technology would most likely render obsolete the
equipment the company purchased a year ago.
The accountant estimates that warranty repairs now cause the firm to lose 20% of its potential
business.
Required
1. What is the total required initial investment cost (cash outlay) associated with the new manufacturing
process?
2. What is the total expected change (i.e., increase or decrease) in cost of quality over the next 3 years from
using the new manufacturing process being proposed?
3. Based solely on financial considerations, should Worrix invest in the new process? Specifically:
(a) What is the cumulative (i.e., 3-year) estimated change in pretax cash flow assuming the new system
is implemented? (b) What is the estimated payback period for the proposed investment (see Chapter
12)? (c) What is the estimated pretax
investment? (Use the built-in IRR function in Excel to answer this question.)
4. What additional factors should be considered before making the final decision?
5. A member of the company’s board of directors is very concerned about the substantial amount of additional funds needed for the new process. Because the current model will be replaced in about 3 years,
the board member suggests that the firm should take no action and the problem will go away in 3 years.
Do you agree? Why or why not?
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