The Tristan Corporation sells 250,000 V262 valves to the automobile and truck in

Question

The Tristan Corporation sells 250,000 V262 valves to the automobile and truck industry. Tristan has a capacity of 150,000 machine hours and can produce two valves per machine hour. V262’s contribution margin per unit is $7. Tristan sells only 250,000 valves because 50,000 valves (20% of the good valves) need to be reworked. It takes 1 machine hour to rework two valves, so 25,000 hours of capacity are used in the rework process. Tristan’s rework costs are $550,000. Rework costs consist of the following:

Direct materials and direct rework labor (variable costs): $5 per unit

Fixed costs of equipment, rent, and overhead allocation: $6 per unit

Tristan’s process designers have developed a modification that would maintain the speed of the process and ensure 100% quality and no rework. The new process would cost $538,000 per year. The demand for Tristan’s V262 valves is 400,000 per year.

Required:

1. Should Tristan implement the new design? (Hint: Think about what can be done with the machine hours that are freed up if rework is eliminated.)

Explanation / Answer

compare the alternatives of (a) not implementing the new design versus
(b) implementing the new design. By implementing the new design, Tristan will save 25,000 machine-hours of rework time. This time can then be used to make and sell 50,000 (2 valves per hour ´ 25,000 hours) additional V262 valves. The relevant costs and benefits of implementing the new design follow:

The relevant costs of implementing the new design                                                     $(538,000)

Relevant benefits:

(a)     Savings in rework costs ($5a per V262 valve ´ 50,000 valves)                     250,000

(b)     Additional contribution margin from selling another

             50,000 V262 valves (2 valves per hour ´ 25,000 hours)

because capacity previously used for rework is freed up

                  ($7 per valve ´ 50,000 units)                                                                350,000

         Net relevant benefit                                                                                             $   62,000

a Note that the fixed rework costs of equipment rent and allocated overhead are irrelevant, because these costs will be incurred whether Tristan implements or does not implement the new design.

            Tristan should implement the new design because the relevant benefits exceed the relevant costs by $62,000.

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