Video Recreation, Inc., (VRI) is a supplier of video games and equipment, such as large-screen televisions and DVD players. The company has recently concluded a major contract with Sunview Hotels to supply games for the hotel video lounges. Under this contract, a total of 4,000 games will be delivered to Sunview Hotels throughout the western United States, and the games will have a warranty period of 1 year for both parts and labor. The number of service calls required to repair these games during the first year after installation is estimated as follows:

Number of Service Calls Probability

400 .1

700 .3

900 .4

1,200 .2

VRIs Customer Service Department has developed three alternatives for providing the warrant service to Sunview. These three plans are presented below.

Plan 1: VRI would contract with local firms to perform the repair services. It is estimated that six such vendors would be needed to cover the appropriate areas and that each of these vendors would charge an annual fee of $15,000 to have personnel available and to stock the appropriate parts. In addition to the annual fee, VRI would be billed $250 for each service call and would be billed for parts used at cost plus a 10% surcharge.

Plan 2: VRI would allow the management of each hotel to arrange for repair service when needed and then would reimburse the hotel for the expenses incurred. It is estimated that 60% of the service call would be for hotels located in urban areas where the charge for a service call would average $450. At the remaining hotels, the charges would be $350. In addition to these service charges, parts would be billed at cost.

Plan 3: VRI would hire its own personnel to perform repair services and to do preventive maintenance. Nine employees located in the appropriate geographical areas would be required to fulfill these responsibilities, and their average salary would be $24,000 annually. The fringe benefit expense for these employees would amount to 35% of their wages. Each employee would be scheduled to make an average of 200 preventive maintenance calls during the year; each of these calls would require $15 worth of parts. Because of this preventive maintenance, it is estimated that the expected number of hotel calls for repair service would decline 30%, and the cost of parts required for each repair service call would be reduced by 20%.

VRIs Accounting Department has reviewed the historical data on the repair costs for equipment installations like those proposed for Sunview Hotels and found that the cost of parts required for each repair occurred in the following proportions:

Parts Cost per Repair Proportion

$30 15%

40 15%

60 45%

90 25%

Question

Video Recreation, Inc., wishes to select the least costly alternative to fulfill its warranty obligations to Sunview Hotels. Recommend which of the three plans presented above should be adopted by VRI. Support your recommendation with appropriate calculations and analysis.