As manager of Dufour, Inc., you receive a report indicating a $20,000 unfavorable labor efficiency variance for the past week’s operations. You estimate the probability of the process being out of control at .40 and the cost to investigate at $1,000. If the process is out of control, the cost to correct the error is estimated to be $2,000 in addition to the $1,000 cost of investigating.

Further, if you do not investigate and the process is out of control, the present value of future unfavorable variances that would be saved by making the necessary changes if the process is operating improperly is $7,600.

Required:

a. Use the expected cost of investigation and no investigation as the basis for your decision.

Should the process be investigated?

b. Determine the level of probability that the process is out of control where the expected costs of each action would be the same.

c. Explain why the present value of the cost savings over the planning period ($7,600 in this case) is not equal to the unfavorable variance ($20,000 in this case).