The Brisbane Manufacturing Company produces a single model of a CD player. Each

Question

The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $205 with a resulting contribution margin of $72.

Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $41,000 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 $75. 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. Competitors are expected to improve their quality control systems in the future, so if Brisbane does not improve its system, sales volume is expected to fall by 510 CD players a year for the next four years. In other words, it will fall by 510 units in the first year, 1,020 units in the second year, etc..

The proposed quality control system involves the purchase of an x-ray machine for $280,000. The machine would last for four years and would have salvage value at that time of $22,000. Brisbane would also spend $780,000 immediately to train workers to better detect and repair defective units. Annual inspection costs would increase by $25,000. This new control system would reduce the number of defective units to 360 per year. 295 of these defective units would be detected and repaired at a cost of $47 per unit. Customers who still received defective players would be given a refund equal to one-and-a-fourth times the purchase price.

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

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

Explanation / Answer

1 Using current System the following will be the cost

If Brisbane Continues the Present System the Net Present value of Lost Contribution would be $114533

2 If Brisbane Replaces the System

IF the system is replaced then additional cost of replacing the system would be $1319375.

Particulars Year-1 Year-2 Year-3 Year-4 TOTAL Inspection Cost $41000 $41000 $41000 $41000 Incremental cost for Fixing Defective Sales return $99750 $99750 $99750 $99750 Refund of Purchase Price($205*570) $116850 $116850 $116850 $116850 Contribution Lost on Decrease of Sales volume $36720 $73440 $$110160 $146880 Total $294320 $331040 $367760 $404480 PV Factor 0.9259 0.8573 0.7938 0.7350 Net Present Value $272511 $283801 $291928 $297293 $1145533

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