The Brisbane Manufacturing Company produces a single model of a CD player. Each
ID: 2566003 • Letter: T
Question
The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $188 with a resulting contribution margin of $75.
Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $39,000 a year to inspect the CD players. An average of 1,800 units turn out to be defective - 1,260 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 $210,000. The machine would last for four years and would have salvage value at that time of $19,000. Brisbane would also spend $610,000 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 370 per year. 320 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 & 2 [0 points; unlimited tries]
1. What is the Year 3 cash flow if Brisbane keeps using its current system?
2. What is the Year 3 cash flow if Brisbane replaces its current system?
Questions 3 & 4 [5 points each; 5 tries each]
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?
Tries 0/99Explanation / Answer
1. Calculation of Year 3 cash flows with current system in place
Inspection of CD players = $39,000 per year
Cost of repairing the defective players = $85 x 1260 players = $107,100
Cost of Refund to customers = (1800 - 1260) x $188 = $101,520
Total Cash Flows = $39,000 + $107,100 + $101,520 = $247,620
NOTE: How many units are sold is not given in question, therefore we have considered only cash outflows.
2. Calculation of Year 3 cash flows with new system in place
Annual Inspection cost per year = $39,000 + $25,000 = $64,000
Repairing cost of Defective units = 320 units x $47= $15,040
Refund to Customers = (370 units - 320 units) x $188 / 4 = $2,350
Total Cash outflows = $81,390
NOTE: Number of units sold is not given, therefore we have considered only cash outflows. Moreover, tax rate is not provided,therefore tax savings on depreciation cannot be calculated.
3. Net Present Value under current system
Total Annual Cost as computed in 1 above = $247,620
Cumulative Present Value at 6% discount rate for 4 years = 1 / (1+0.06)1+2+3+4
= 3.465
Net Present Value of cash outflows = $247,620 x 3.465 = $858,003.3
4. Net Present Value under new System
Particulars
Amount (In $)
(A)
Time(n)
Present Value Factor (1/ (1.06)n), i=6%
(B)
Present Value Amount (In $)
(A x B)
Cash Outflows:
Purchase of Machine
210,000
0
1
210,000
Training of Staff
610,000
0
1
610,000
Annual Inspection Cost
64,000
1-4
3.465 (Cumulative Present Value)
221,760
Repairing of Defects
15,040
1-4
3.465 (Cumulative Present Value)
52,113.6
Refund to Customer
2,350
1-4
3.465 (Cumulative Present Value)
8,142.75
TOTAL CASH OUTFLOWS
1,102,016.35
Salvage Value of Asset
19,000
4
0.7921
(15,050)
Net Present Value of Cash outflows
1,086,966.35
NOTE: In the given, according to me number of units sold is required to calculate the Actual Net Present Value. IN the absence of same we have considered Net Present Value of Cash Outflows only.
Particulars
Amount (In $)
(A)
Time(n)
Present Value Factor (1/ (1.06)n), i=6%
(B)
Present Value Amount (In $)
(A x B)
Cash Outflows:
Purchase of Machine
210,000
0
1
210,000
Training of Staff
610,000
0
1
610,000
Annual Inspection Cost
64,000
1-4
3.465 (Cumulative Present Value)
221,760
Repairing of Defects
15,040
1-4
3.465 (Cumulative Present Value)
52,113.6
Refund to Customer
2,350
1-4
3.465 (Cumulative Present Value)
8,142.75
TOTAL CASH OUTFLOWS
1,102,016.35
Salvage Value of Asset
19,000
4
0.7921
(15,050)
Net Present Value of Cash outflows
1,086,966.35
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