The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $207 with a resulting contribution margin of $77.
Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $39,500 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 $75. 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 520 CD players a year for the next five years. In other words, it will fall by 520 units in the first year, 1,040 units in the second year, etc..
The proposed quality control system involves the purchase of an x-ray machine for $310,000. The machine would last for five years and would have salvage value at that time of $22,000. Brisbane would also spend $810,000 immediately to train workers to better detect and repair defective units. Annual inspection costs would increase by $25,000. This new control system would reduce the number of defective units to 360 per year. 290 of these defective units would be detected and repaired at a cost of $46 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 2 cash flow if Brisbane keeps using its current system?
2. What is the Year 2 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?