Worrix Corporation manufactures and sells each year 3,000 premium-quality multimedia projectors at $12,000 per unit. 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 installation 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 per unit 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.

 

Production and sales volume (# projectors)		3,000
Selling price per unit		$12,000
Variable manufacturing costs (per unit)		$2,500
Fixed manufacturing costs (per year)		$6,000,000
Fixed selling, administrative, and other expenses per year		$10,000,000
Sales commission rate (per dollar of sales)		15%
Reworks (percent of units produced)		40%
Warranty repair rate (based on sales volume)		15%
Annual fixed costs associated with rework activity		$1,800,000
Variable costs (per unit reworked)		$2,000
Variable repair cost per unit		$2,500
New process cost		$12,000,000
Estimated life of proposed project (years)		3
Training cost associated with new process		$3,000,000
Per unit appraisal cost eliminated by new process		$50
Avoidable fixed appraisal costs (with new process)		$600,000
New warranty repair cost per unit		$1,000
Estimated new warranty repair rate (percent of the units shipped)		5%
Opportunity cost		20%

Required

1. What is the net investment cost associated with the new process?

2. What is the net financial benefit (over the next three years) from using the new process?

3. Based on financial information, should Worrix use the new process?

4. What additional factors should be considered before making the final decision?

5. A member of the board is very concerned about the substantial amount of additional funds needed for the new process. Because the current model will be replaced in about three years, the board member suggests that the firm should take no action and the problem will go away in three years. Do you agree?