Question - The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $202 with a resulting contribution margin of $70.
Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $41,500 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 the rest are shipped to customers. If a defective CD player is identified in the inspection process, it costs $75 to fix it. 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 450 CD players a year for the next four years. In other words, it will fall by 450 units in the first year, 900 units in the second year, etc..
The proposed quality control system has two elements. First, Brisbane would spend $780,000 immediately to train workers to better detect and correct defective units. Second, an x-ray machine would be purchased to improve detection. This machine would cost $310,000, last for four years, and have salvage value at that time of $22,000. Annual inspection costs would increase by $23,000. Both of these elements would reduce the number of defective units to 350 per year. 285 of these defective units would be detected and repaired at a cost of $40 per unit. Customers who received defective players would be given a refund equal to one-and-a-fourth times the purchase price.
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?
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?