The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $200 with a resulting contribution margin of $74.
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 2,000 units turn out to be defective - 1,400 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 five years and would have salvage value at that time of $21,000. Brisbane would also spend $600,000 immediately to train workers to better detect and repair defective units. Annual inspection costs would increase by $20,000. 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 $42 per unit. Customers who still received defective players would be given a refund equal to one-and-a-half 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?