Inventory Level and Quality Level.

A consulting firm developed the following schedule depicting the relationships between product quality and various resources used within manufacturing operations. The two columns on the right show an index of how much labor and inventory acompany must have on hand for various levels of quality. With perfect quality the index is 100.

For example, at a quality level that produces 10% defects a company must have 130%

as much labor as one that produces at a rate of 100 defects per million, and it must carry 150% as much inventory as one that produces 100 defects per million.

Fraction Defective Labor Index Inventory Index

: 1 130 150 8.00% 126 145 6.00% 121 139 4.00% DES 132 2.00% 108 124 1.00% 102 112 0.10% 101 102 0.01% 100 100 Your boss saw this table and asked you to estimate the value of increasing quality at your company. Your company currently spends $2,600,000 per year on wages, and it carries

$15,000,000 in inventory. It also generates ten percent defectives with present operations and has an annual inventory carrying cost estimated at 20%.

Required:

a. Compute the annual profit effect of reducing the defective rate from 10% to 6% if the company incurs an additional annual cost of $50,000 to reduce the fraction defective.

b. Compute the annual labor cost if the company produces product with a defect rate of one hundred parts per million.

c. Compute the total annual cost reduction from current levels if the company can produce with a 1% defect rate.

d. Discuss the types of costs a company incurs as a result of poor quality.

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