Question
A company is producing a high-volume item that sells for $0.65 per unit. The variable production cost is $0.40 per unit. The company is able
A company is producing a high-volume item that sells for
$0.65
per unit. The variable production cost is
$0.40
per unit. The company is able to produce and sell
11,000,000
items per year when operating at full capacity.
a. If the company's MARR is
12%
per year, is the purchase of the new machine to improve quality (reduce variability) economically attractive? Use the AW method to make your recommendation.
b. Compute the IRR, simple payback period, and discounted payback period of the proposed investment.
The critical attribute for this product is weight. The target value for weight is
1,500
grams, and the specification limits are set at
45
grams. The filling machine used to dispense the product is capable of weights following a normal distribution with an average
()
of
1,500
grams and a standard deviation
()
of
45
grams. Because of the large standard deviation (with respect to the specification limits),
21.6%
of all units produced are not within the specification limits. (They either weigh less than
1,455
grams or more than
1,545
grams.) This means that
2,376,000
out of
11,000,000
units produced are nonconforming and cannot be sold without being reworked.
Assume that nonconforming units can be reworked to specification at an additional fixed cost of
$0.10
per unit. Reworked units can be sold for
$0.65
per unit. It has been estimated that the demand for this product will remain at
11,000,000
units per year for the next five years.
To improve the quality of this product, the company is considering the purchase of a new filling machine. The new machine will be capable of dispensing the product with weights following a normal distribution with
=1,500
grams and
=25
grams. As a result, the percent of nonconforming units will be reduced to
1.4%
of production. The new machine will cost
$670,000
and will last for at least
five
years. At the end of fiveyears, this machine can be sold for
$120,000.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started