Relevant Cost Analysis – Quality Improvement An automobile manufacturer plans to
ID: 2589470 • Letter: R
Question
Relevant Cost Analysis – Quality Improvement
An automobile manufacturer plans to spend $1 billion to improve the quality of a new model. The manufacturer expects the quality-improvement program to eliminate the need for recall and reduce the costs for other warranty repairs. The firm’s experience had been, on average, 1.5 recalls for each new model at a cost of $300 per vehicle per recall. The average cost per recall, if one is needed, is expected to increase by 10 percent for the new model. Costs for other warranty repairs are expected to decrease from $200 to $80 per unit sold. Sales of the new model were expected to be 500,000 units without the quality-improvement program. The company believes that the well-publicized quality-improvement program will increase total sales of 650,000 units.
Please answer the following question
If there is a profit of $5,000 per unit on any incremental sales attributable to the quality-improvement program, is the $1 billion expenditure justified?
Explanation / Answer
$1 billion expenditure on quality-improvement program to eliminate the need for recall and reduce the costs for other warranty repairs is justifiable as net increase in revenue will be $ 1,97,50,000
Particular Amount a Incremental Profit 75,00,00,000 ($ 5,000 * 1,50,000 unit) b Recall Cost to Be Save 32,17,50,000 Cost per recall $330 No. of call 1.5 / vehicle (6,50,000 * 330 * 1.5) Total Increase in Revenue 1,07,17,50,000 c Cost of Warrenty 5,20,00,000 ($ 80 * 6,50,000) d Net Increase in Revenue 1,01,97,50,000 e Cost of quality-improvement program 1,00,00,00,000 Net Revenue 1,97,50,000