Hello, I am confused with the processes needed to complete the problem. Any help

Question

Hello, I am confused with the processes needed to complete the problem. Any help would be greatly appreciated.

A small but important raw material is an ingredient in a special plastic used in automobile bumpers. The raw material costs $.50 per bumper. The plastic costs $5. The bumpers have a variable manufacturing cost of $25 each. XYZ Motor Company buys the bumpers from the bumper supplier for $40 each and assembles them into its autos. When a repair shop orders a replacement bumper, it buys bumpers for $100 each and charges the car owner $250 including labor to replace it. The original raw material has a bad batch that goes into 10,000 front bumpers. While the bad raw material originally costs $5,00, the problem is not discovered until all 10,000 cars have been sold. The government requires XYZ to recall all the cars and have their front bumpers replaced. What is the closest estimate of the failure cost to XYZ and its 10,000 customers? (a) $400,000 minus $250,000 refunded by the bumper supplier, or $150,000 (b) $1 million (c) $2 million (d) $3 million Justify your choice with some rough calculations based on the information given. (Think of the different categories of costs involved. Estimate each of these costs and provide some justification for the numbers.)

Explanation / Answer

Here, the visible cost is just the Bumpers cost incurred by XYZ motor company minus the cost it will recover from its supplier because of faulty bumpers it supplied. But the visible cost of a product recall is just the tip of the iceberg. The majority of the total cost of a recall are the hidden costs as listed below:

Note: The numbers approximated are conservative. Actuals may be even more.

$ 400,000 – 250,000 =150,000 Cost of Manufactured Goods

$ 500,000: Business Interruption (Because customers will be reluctant to buy cars due to quality issues))

$ 100*10000= 1,000,000: Customer Reimbursement (To provide for transportation costs till their cars are          returned)

$ 60*10000= 600,000 Transportation (Bringing cars to the company and transporting back to customers)

$ 5000: External Professional Fees (To conduct quality checks)

$ 100,000: Costs at Production Facilities (Labor costs to replace bumpers + preparing assembly to work on 10000 cars)

$ 5000: Warehousing Costs (To store removed Bumpers)

$ 10,000: Loss of Brand/Reputation (Short term stock losses and loss of sales)

The approximate Costs that will be incurred by XYZ based on the above mentioned costs will be $2.1 million, which is very close to $2 million.

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