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Inspection Cost

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A company is considering additional final inspection costs of $1 per unit before delivery to customers. It currently delivers 60,000 units per year. The additional inspection should reduce the defective rate from 3 percent to 1 percent. If a defective unit is found, it is scrapped at no additional cost. The manufacturing costs before the final inspection are $200 per unit. The management believes that the external failure costs are $40 per defective unit.

a. State the amount of the current cost of external failures.
b. Should the management incur the additional inspection costs? Why or why not?

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Solution Summary

This solution illustrates how to compute the cost of external failures and to determine whether a company should incur additional inspection costs.

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a. State the amount of the current cost of external failures.

The current cost of external failures is 60,000 (units) *.03 (failure rate) *$40 (cost per external failure) or $72,000.

b. ...

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