david corporation

David Corporation manufactures and sells each year 3,000 premium-quality multimedia projectors at $12,000 per unit. At the current production level, the firm's manufacturing costs include variable costs of $2,500 per unit and annual fixed costs of $6,000,000. Selling, administrative, and other expenses, not including 15 percent sales commissions, are $10,000,000 per year. The new model, introduced a year ago, has experienced a flickering problem. On average the firm reworks 40 percent of the completed units and still has to repair under warranty 15 percent of the units shipped. The additional work required for rework and repair causes the firm to add additional capacity with annual fixed costs of $1,800,000. The variable costs per unit are $2,000 for rework and $2,500, including transportation cost, for repair. The chief engineer, Lucky Liu, has proposed a modified manufacturing process that will almost entirely eliminate the flickering problem. The new process will require $12,000,000 for new equipment and installation, and $3,000,000 for training. The firm currently inspects all units before shipment. Lucky believes that current appraisal costs of $600,000 per year and $50 per unit can be eliminated within 1 year after the installation of the new process. Furthermore, if the new investment is made, warranty repair cost per unit is estimated to be only $1,000, for no more than 5% of the units shipped. David believes that none of the fixed costs of rework or repair can be saved and that a new model will be introduced in three years. This new technology would most likely render obsolete the equipment the company purchased a year ago. The accountant estimates that repairs cost the firm 20 percent of its business.Data Production and sales volume (# projectors} Selling price per unit Variable manufacturing costs (per unit} Fixed manufacturing costs (per year} Fixed selling, administrative, and other expenses per year Sales commission rate (per dollar of sales} Reworks (percent of units produced} Warranty repair rate (based on sales volume} Annual xed costs associated with rework activity Variable costs (per unit reworked} Variable repair cost per unit New process cost Estimated life of proposed project (years} Training cost associated with new process Per unit appraisal cost eliminated by new process Avoidable xed appraisal costs (with new process} New warranty repair cost per unit Estimated new warranty repair rate (percent ofthe units shipped} Opportunity cost 3,000 $12,000 $2,500 $8,000,000 $10,000,000 15% 40% 15% $1 $00,000 $2,000 $2,500 $12,000,000 3 $3,000,000 $50 $800,000 $1,000 5% 20% Requirements 1. What is the total required initial investment cost (cash outlay) associated with the new manufacturing process? 2. What is the total expected change (i.e., increase or decrease) in quality costs over the next three years from using the new manufacturing process being proposed? 3. Based soley on financial considerations, should David invest in the new process? Specifically: (a) what is the cumulative (i.e., three-year) change in pre-tax cash flow assuming the new system is implemented? (b) What is the estimated payback period for the proposed investment? and (c) What is the estimated internal rate of return (IRR) for the proposed investment (to two [2] decimal places)? 4. What additional factors should be considered before making the final decision? 5. A member of the company's board of directors is very concerned about the substantial amount of additional funds needed for the new process. Because the current model will be replaced in about three years, the board member suggests that the firm should take no action and the problem will go away in three years. Do you agree