Chapter 17, Problem 76P

1.

To determine

Identify the incremental cost for each of the two decision alternatives.

Explanation of Solution

Incremental cost (cash outlay) for each decision alternative are as follows:

Decision alternative 1: “One-time” process re-engineering is $160,000.

Decision alternative 2: “Annual” cost of equipment lease is $100,000.

2.

To determine

Calculate the estimated year 1 financial benefit associated with each decision alternative.

Explanation of Solution

Calculate the estimated year 1 financial benefit for decision one alternative 1.

Particulars	Amount ($)	Amount ($)
Cost savings:
Reduction in cost to rework defective products $\left(\begin{array}{l}\left(\begin{array}{l}\text{\$100}\text{.00 per hour }\\ \text{×30\% variable cost rate}\end{array}\right)\\ \text{× 3,000 hours saved}\end{array}\right)$		90,000
Reduction in number of deliveries $\left(\begin{array}{l}\left(\begin{array}{l}\text{\$150 per delivery }\\ \text{×60\% variable cost rate}\end{array}\right)\\ \text{× 75 saved deliveries}\end{array}\right)$		6,750
Reduction in customer-support $\left(\begin{array}{l}\left(\begin{array}{l}\text{\$50 per hour }\\ \text{×50\% variable cost rate}\end{array}\right)\\ \text{× 300 hours saved}\end{array}\right)$		7,500
Reduction in field-service hours $\left(\begin{array}{l}\left(\begin{array}{l}\text{\$120 per hour }\\ \text{×40\% variable cost rate}\end{array}\right)\\ \text{× 2,800 hours saved}\end{array}\right)$		134,400
Total projected quality-related cost savings		238,650
Contribution margin provided by increased sales:
Estimated increased sales volume	800,000
Estimated contribution margin %	30%	240,000
Year-one financial benefit, Decision Alternative 1		478,650

Table (1)

Calculate the estimated year 1 financial benefit for decision one alternative 2.

Particulars	Amount ($)	Amount ($)
Cost savings:
Reduction in cost to rework defective products $\left(\begin{array}{l}\left(\begin{array}{l}\text{\$100}\text{.00 per hour }\\ \text{×30\% variable cost rate}\end{array}\right)\\ \text{× 2,000 hours saved}\end{array}\right)$		60,000
Reduction in number of deliveries $\left(\begin{array}{l}\left(\begin{array}{l}\text{\$150 per delivery }\\ \text{×60\% variable cost rate}\end{array}\right)\\ \text{×50 saved deliveries}\end{array}\right)$		4,500
Reduction in customer-support $\left(\begin{array}{l}\left(\begin{array}{l}\text{\$50 per hour }\\ \text{×50\% variable cost rate}\end{array}\right)\\ \text{× 200 hours saved}\end{array}\right)$		5,000
Reduction in field-service hours $\left(\begin{array}{l}\left(\begin{array}{l}\text{\$120 per hour }\\ \text{×40\% variable cost rate}\end{array}\right)\\ \text{× 2,600 hours saved}\end{array}\right)$		124,800
Total projected quality-related cost savings		194,300
Contribution margin provided by increased sales:
Estimated increased sales volume	600,000
Estimated contribution margin %	30%	180,000
Year-one financial benefit, Decision Alternative 2		374,300

Table (2)

3.

To determine

Calculate the estimated year 1 net difference between the decision alternatives. Identify the decision alternative that is preferable.

Explanation of Solution

Calculate the estimated year 1 net financial difference.

Particulars	Amount ($)
Decision alternative 1	318,650
Decision alternative 2	274,300
Net financial difference	44,350

Table (3)

Note: The $44,350 is favor of decision alternative 1.

4.

To determine

Explain the results obtained in part (1), (2) and (3) in terms of COQ reporting model and any other relevant to manufacturing and control of quality.

Explanation of Solution

Based on the financial analysis shown above alternative 1 is preferable. Both decision alternatives yield a net one year financial benefit. Even though the alternative 1’s implementation cost is greater than the alternative 2’s implementation cost, the alternative 1 benefits exceeds alternative 2.

In each cash spending increases:

• Alternative 1 needs increased spending on prevention costs.
• In case of alternative 2, it needs increased spending on appraisal cost.

But in both the cases company predicts a decrease in internal and external cost (failure cost) and increase in sales dollar in return. Finally, a key advantage of COQ reporting is to track total quality relevant spending over time, the overall spending components.

5.

To determine

Explain the strategic considerations which bear upon the decision facing D Company.

Explanation of Solution

Financial Strategic Considerations:

1. a. The underlying investments provides benefits beyond a single year, hence, analysis that are informed would involve   discounting amount of future to basis of present value.
2. b. The problem shows that each of the two investment alternatives reduces activities that are related to quality, which increases the capacity resources that are related to capacity. Yet spending on the activities doesn’t decrease in response to activity. D Management should observe the capacity related resources spending in areas that are addressed in the problem.
3. c. Analysis of fuller financial of the competing alternatives attempts to deal with the estimates that are uncertain.

Non-Financial Strategic Considerations:

a. State whether the decision alternatives among the two would result in a down time and therefore, opportunity costs with respect to lost revenues.

b. Provide information whether the choice affect any additional performance metrics including non-financial performance indicators. Assume that the present analysis focus on the impact of the decision on a limited set of quality related financial metrics.

c. State whether there are any other strategically important projects that might not have a funding priority. Assume that the present analysis focus on a subset of the company's products.

d. State whether the analysis of employee training costs for either or both alternatives was included or not.

e. Determine whether the product in question is scheduled for a large makeover in the near future. Consider the lower-cost option to be preferred.