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 $207 with a resulting contribution margin of $80.

Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $40,500 a year to inspect the CD players. An average of 2,200 units turn out to be defective - 1,760 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. 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 530 CD players a year for the next five years. In other words, it will fall by 530 units in the first year, 1,060 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 five years and would have salvage value at that time of $20,000. Brisbane would also spend $780,000 immediately to train workers to better detect and repair defective units. Annual inspection costs would increase by $22,000. This new control system would reduce the number of defective units to 390 per year. 340 of these defective units would be detected and repaired at a cost of $42 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 2 cash flow if Brisbane keeps using its current system?

2. What is the Year 2 cash flow if Brisbane replaces its current system?

Questions 3 & 4 [5 points each; 5 tries each]
3. Assuming a discount rate of 8%, what is the net present value if Brisbane keeps using its current system?

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

Explanation / Answer

As no other information is given Cash Flow is calculated on basis of Data Provided In the question, Taking 2200 Units as base Year 2 Cash flow if Machine is not changed Contribution for 2200 Units 176000 Less: Cost of Inspection -40500 Less: Cost of Repairs for 1760 -149600 Less:Refund of Defective Units 440 Units -91080 Less:Loss of Sales for 1060 Units -84800 Total Inflow -189980 Year 2 cash flow if Machinery is purchased Contribution for 2200Units 176000 Less:Cost of Inspection -62500 Less:Cost of Repairs -14280 Less:Refund to Customers 50 Units -12937.5 Cash Inflow 86282.5 Depreciation is ignored as tax details are not avaialable. Net Present Value(If Current System is used) Contribution Cost of Inspection Cost of Repairs Refund of Defective Units Loss of Sales Each Year Cash Flows Discounting Factor Year 1 176000 40500 149600 91080 42400 -147580 0.925926 -136648 Year 2 176000 40500 149600 91080 84800 -189980 0.857339 -162877 Year 3 176000 40500 149600 91080 127200 -232380 0.793832 -184471 Year 4 176000 40500 149600 91080 169600 -274780 0.73503 -201972 Year 5 176000 40500 149600 91080 212000 -317180 0.680583 -215867 TOTAL NPV -901835 Net Present Value(If System is changed) Contribution Cost of Inspection Cost of Repairs Refund to Customers Total Inflows Discounting Factor Year 1 176000 62500 14280 12938 86282 0.925926 79890.74 Year 2 176000 62500 14280 12938 86282 0.857339 73972.91 Year 3 176000 62500 14280 12938 86282 0.793832 68493.43 Year 4 176000 62500 14280 12938 86282 0.73503 63419.85 Year 5 176000 62500 14280 12938 86282 0.680583 58722.08 Total Cash Inflows 344499 Less: Cash Outflow Machinery -280000 Training Cost -780000 Total NPV -715501

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