Problem - Regal Products has a budget of $900,000 in 2010 for prevention costs. If it decides to automate a portion of its prevention activities, it will save $60,000 in variable costs. The new method will require $18,000 in training costs and $120,000 in annual equipment costs. Management is willing to adjust the budget for an amount up to the cost of the new equipment. The budgeted production level is 150,000 units.
Appraisal costs for the year are budgeted at $600,000. The new prevention procedures will save appraisal costs of $30,000. Internal failure costs average $15 per failed unit of finished goods. The internal failure rate is expected to be 3% of all completed items. The proposed changes will cut the internal failure rate by one-third. Internal failure units are destroyed. External failure costs average $54 per failed unit. The company's average external failures average 3% of units sold. The new proposal will reduce this rate by 50%. Assume all units produced are sold and there are no ending inventories.
i. What is the net change in the budget of prevention costs if the procedures are automated in 2010? Will management agree with the changes?
ii. How much will appraisal costs change assuming the new prevention methods reduce material failures by 40% in the appraisal phase?
iii. How much will internal failure costs change if the internal product failures are reduced by 50% with the new procedures?
iv. How much do external failure costs change if all changes are as anticipated with the new prevention procedures? Assume all units produced are sold and there are no ending inventories.
v. Management has offered to allow the prevention changes if all changes take place as anticipated and the amounts netted are less than the cost of the equipment. What is the net impact of all the changes created by the preventive changes?