Verasource Microprocessor Corporation (VMC) sells 2000 specialized computer processing chips each month at a price of $1,500 each. Variable costs amount to $1,500,000, and fixed costs are $500,000. Currently the company has a defect rate of 8 percent (which are chips returned by customers, scrapped by VMC, and replaced). Note that the variable costs include the cost of producing the defective chips.
a. What is the hidden cost to the company of making this rate of defectives instead of 2,000 good chips each month?
b. Suppose a Six Sigma effort can reduce the defects to a six sigma level (assume for simplicity that the defective rate is essentially zero). What is the impact on profitability?