Selection of Production Plan (Adapted from Malcom Pye, “Reasons, Probabilities, and Accounting Principles,” Accounting Review, Vol. XX XV, No. 3, pp. 440-41.) Assume that the XYZ Company manufactures the Gadget, in which a Gismo is installed. The Gismo costs $10, but when a Gadget is returned because of a defective Gismo, the replacement cost of the Gismo will be $25 because of special handling and the necessary dismantling of the Gadget. Prior to the installation of the Gismo, these alternatives are available to management: L01 1. If the Gismos are tested by random sampling, quality can be controlled so that only 3 percent of the installed Gismos will be defective. The average cost of such sampling, per Gadget, is $.10.

2. All Gismos can be tested and no replacements will be necessary. The average cost of sampling is $1.50.

3. The manufacturer of the Gismo will guarantee that 92 percent will be good.

The cost of replacing Gismos in excess of this 8 percent level will be borne by that manufacturer. However, the price per Gismo will be $10.25.

Assume that annual production is 100,000 units. Select an alternative. Show computations.