Question

A manager of Paris manufacturing which produces computer hard drives, is planning to lease a new automated inspection system. The manager believes the new system will be more accurate than the current manual inspection process. The firm has had problems with hard drive defects in the past and the automated system should help catch these defects before the drives are shipped to the final assembly manufacturer. Below are the relevant information:

Current manual inspection system:
annual fixed cost = $35,000
Inspection variable cost per unit = $15 per unit.

New automated inspection system:
Annual fixed cost = $165,000
Inspection variable cost per unit = $0.55 per unit

1- Suppose annual demand is 8000 units. Should the firm lease the new inspection system?

2- NEW-SPEC, a firm that specializes in providing manual inspection processes for other firms, approached Paris manufacturing and offered to inspect parts for $19 each with no fixed costs. It assured Paris manufacturing that the accuracy and quality of its manual inspections would equal that of the automated inspection system. Demand for the upcoming year is forecast to be 8000 units. Should the manufacturer accept the offer?

Answer 1

Answer:

Paris Manufacturing

1. Based on cost considerations, the new inspection system should not be leased.  

2. Based on cost considerations, the manufacturer should accept the NEW-SPEC offer.

Explanation:

a) Data and Calculations:

Annual demand for computer hard drives = 8,000 units

Current manual inspection system:

annual fixed cost = $35,000

Inspection variable cost per unit = $15 per unit.

Total cost for manual inspection system:

Variable costs $120,000 (8,000 * $15)

Fixed costs         35,000

Total costs      $155,000

New automated inspection system:

Annual fixed cost = $165,000

Inspection variable cost per unit = $0.55 per unit

Total cost for automated inspection system:

Variable costs     $4,400 (8,000 * $0.55)

Fixed costs        165,000

Total costs      $169,400

Total cost with NEW-SPEC:

Variable costs     $152,000 (8,000 * $19)

b) The improved efficiency will surely outrun the cost of the new automated inspection system.  Therefore, I recommend that Paris should go ahead with the new system, despite the costs.  Accepting the offer from NEW-SPEC provides the best financial efficiency.  However, in the long-run, purchasing the automated inspection system might prove to be the best decision.