A company is producing a high-volume item that sells for $0.65 per unit. The variable production cost is $0.40 per unit. The company is able to produce and sell 9,000,000 items per year when operating at full capacity.
a. If the? company's MARR is 12% per year, is the purchase of the new machine to improve quality? (reduce variability) economically attractive? Use the AW method to make your recommendation.
b. Compute the IRR, simple payback period, and discounted payback period of the proposed investment.
ADDITIONAL INFORMATION ABOUT NONCONFORMING UNITS AND THE NEW FILLING MACHINE:
The critical attribute for this product is weight. The target value for weight is 1,500 grams, and the specification limits are set at ±45 grams. The filling machine used to dispense the product is capable of weights following a normal distribution with an average (μ) of 1,500 grams and a standard deviation (σ) of 45 grams. Because of the large standard deviation? (with respect to the specification limits), 20.21% of all units produced are not within the specification limits.? (They either weigh less than 1,455 grams or more than 1,545 ?grams.) This means that 1,818,900 out of 9,000,000 units produced are nonconforming and cannot be sold without being reworked.
Assume that nonconforming units can be reworked to specification at an additional fixed cost of $0.15 per unit. Reworked units can be sold for $0.65 per unit. It has been estimated that the demand for this product will remain at 9,000,000 units per year for the next five years.
To improve the quality of this product, the company is considering the purchase of a new filling machine. The new machine will be capable of dispensing the product with weights following a normal distribution with μ = 1,500 grams and σ = 25 grams. As a result, the percent of nonconforming units will be reduced to 1.39% of production. The new machine will cost $710,000 and will last for at least five years. At the end of five years, this machine can be sold for $90,000.