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Relevant Cost Analysis

What are the additional costs of choosing the new process?
Worrix Corporation manufactures and sells 3,000 premium quality multimedia projectors at $12,000 per unit e
ach year. 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. Additional 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, Patti Mehandra, 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 i
nstallation and $3,000,000 for training. Patti believes that current appraisal costs of $600,000 per year and
$50 per unit can be eliminated within one year after the installation of the new process. The firm currently
inspects all units before shipment. Furthermore, warranty repair cost will be only $1,000 for no more than 5
percent of the units shipped.

Worrix 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. The new technology will most likely render the current equipment obsolete.

The accountant estimates that repairs cost the firm 20 percent of its business.

Units 3000 Selling price $12000
Costs Old option New manufacturing process
Variable cost/unit $2,500
Annual Fixed Cost $6,000,000
Additional selling, Administrative and other expenses $100,000,000
Sales Commisions 15 % of sales
Appraisal cost $600,000
Variable appraisal cost/unit $50

Rework 40% of completed unit
Repair under warranty 15% of units shipped
Fixed cost of repairs $1,800,000
Variable cost/unit Reworked $2,000
Variable cost/unit repaired $2,500

new equipment fixed cost $12,000,000
Warranty repair cost for 5% of the units shipped

What are the additional costs of choosing the new process?


Solution Summary

This posting contains relevant cost analysis for an existing and a new process.