Question:
An existing piece of equipment is currently generating 15% scrap. The value of the scrap including material, labor, and overhead costs is $I0.50 per unit. The current rate of output from the process is 1,000 units per month of both good and bad product. The existing equipment was purchased five years ago for $230,000. Current operating costs are $10,000 per year. Its current market value is $135,000. It has three more years of life remaining. A quality improvement team has estimated that the scrap rate could be reduced to 4% if new tooling and major overhaul work could be performed and some of the major components could be replaced. The improvements would also reduce the annual operating costs from $10,000 down to $6,000 per year. If the organization requires 15% return on its investments, what is the maximum that could be spent on the equipment to reduce the scrap rate?