Pension Plan for Ladies

7/27/2019 Pension Plan for Ladies

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Exercise 19-17: Cost of Quality AnalysisDefinitions:

Prevention Costs: Costs incurred to preclude the production of products

that do not conform to quality specifications.Appraisal Costs: Costs incurred to detect which of the individual units of

products do not conform to quality specifications.

Internal Failure Costs: Costs incurred on a defective product before it isshipped to customers.External Failure Costs: Costs incurred on a defective product after it is

shipped to customers.

Dream Rider produces car seats for children from newborn to 2 years old.The company is worried because one of its competitors has recentlycome under public scrutiny because of product failure. Historically,Dream Rider's only problem with its car seats was stitching in the straps.The problem can usually be detected and repaired during an internalinspection. The cost of the inspection is $4, and the repair cost is $.75.

All 250,000 car seats were inspected last year and 9% were found to

have problems with the stitching in the straps during the internalinspection. Another 3% of the 250,000 car seats had problems with thestitching, but the internal inspection did not discover them. Defectiveunits that were sold and shipped to customers needed to be shippedback to Dream Rider and repaired. Shipping costs are $7, and repaircosts are $.75. However, the out-of-pocket costs (shipping and repair)are not the only costs of defects not discovered in the internalinspection. For 20% of the external failures, negative word of mouthwill result in a loss of sales, lowering the following year's sales by $300for each of the 20% of units with external failures.

Required:1. Calculate appraisal cost.

Appraisal cost = inspection cost = $4 X 250,000 car seats = $1,000,0001000000

2. Calculate internal failure cost.

Internal failure costs = rework costs = (9% X 250,000) X $.75 = $16,87516875

3. Calculate out-of-pocket external failure cost,

Out-of-pocket cost = (shipping cost + repair cost) X defective units

Out-of-pocket cost = ($7 + $.75) X (3% X 250,000) = $7.75 X 7,500 = $58,125

581254. Determine the opportunity cost associated with the external failures

External failures = Lost future sales = (3% X 250,000) X 20% X $300

External failures = 7,500 X 20% X $300 = 1,500 X $300 = $450,000

5. What are the total cost of Quality?


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Appraisal costs $1,000,000Internal failure $16,875External failure (out-of-pocket) $58,125External failure (lost sales) $450,000

Total $1,525,000

6. Dream Rider is concerned with the high up-front cost of inspecting all250,000 units. It is considering an alternative internal inspection plan thatwill cost only $1.00 per car seat inspected . During the internal inspection,

the alternative technique will detect only 5% of the 250,000 car seats ashaving stitching problems. The other 7% with stitching problems will bedetected after the car seats are sold and shipped. What are the total costsof quality for the alternative technique.

Appraisal cost = $1.00 X 250,000 = $250,000

Internal failure cost = (.05 X 250,000) X $.75 (rework) = $9,375

External failure (out-of-packet) costs =7% X 250,000 X ($7 + $.75) = $135,625

External failure (0pportuniy cost) =20% X (.07 X 250,000) X $300 = $1,050,000

Total cost of quality control = Appraisal costs $250,000 Internal failure $9,375 External failure (out-of-pocket) $135,625 External failure (lost sales) $1,050,000

Total $1,445,000

7. What factors other than cost should Dream Rider consider before changing

inspection techniques?

In addition to lower costs under the alternative inspection plan, Dream Ridershould consider a number of other factors.

a. There could easily be serious reputation effects if the % of external failures increases by 133% from 3% to 7% This rise in external failures may lead to costs greater than $500 per failure due to lost sales.

b. Higher external failure rates may increase the probability of lawsuits.

c. Government intervention is a concern, with the chances of government regulation increasing with the number of external failures.

Exercise 19-18: Cost of Quality, Ethical Considerations

Refer to information in Exercise 19-17 in answering this question. Dream Rider has discovered a moreserious problem with the plastic core of its car seats. An accident can cause the plastic in some of theseats to crack and break, resulting in serious injuries to the occupant. It is estimated that this problemwill affect about 175 car seats in the next year. This problem could be corrected by using a higherquality of plastic that would increase the cost of every car seat produced by $15. If this problem is notcorrected, Dream Rider estimates that out of the 175 accidents, customers will realize that the problem


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is due to a defect in the seats in only three cases. Dream Rider's legal team has estimated that each ofthese three accidents would result in a lawsuit that could be settled for about $775,000. All lawsuitssettled would include a confidentiality clause, so Dream Rider's reputation would not be affected.

1. Assuming that Dream Rider expects to sell 250,000 car seats next year, what would be thecost of increasing the quality of all 250,000 car seats?

$15 X 250,000 = $3,750,000

2. What will be the total cost of the lawsuits next year if the problem is not corrected?

3 X $775,000 = $2,325,000

3. Dream Rider has decided not to increase the quality of the plastic because the cost ofincreasing the quality exceeds the benefits (saving the cost of lawsuits). What do youthink of this decision? (Note: Because of the confidentiality clause, the decision will haveno effect on Dream Rider's reputation.)

While economically this may seem like a good decision, qualitative factors should be moreimportant than quantitative factors when it comes to protecting customers from harm andinjury. If a product can cause a customer serious harm and injury, an ethical and moralcompany should take steps to prevent that harm and injury. The company's code of ethicsshould guide this decision.

4. Are there any other costs or benefits that Safe Rider should consider?

In addition to ethical considerations, the company should consider the societal cost of this decision,reputation effects if word of these problems leaks out at a later date, and governmental interventionand regulation.


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Exercise 19-20 Quality improvement, relevant costs, relevant revenuesGiven:SpeedPrint manufactures and sells 18,000 high-technology printing presses each year.

The variable and fixed costs of rework and repair are as follows:

Variable Fixed Total

Costs Costs CostsRework costs per hour $79 $115 $194Repair costs

Customer-support costs per hour 35 55 90Transportation costs per load 350 115 465Warranty repair costs per hour 89 150 239

Quality Problem: Current presses have a quality problem which causes viarations in theshade of some colors.Proposal: Change a key component in each press

Extra cost of new component $70

Component per press 1# of presses requiring component 18,000Time horizon (in years) 1

Advantages/Savings with component changeFixed rework costs saved $0Fixed repair costs saved $0Rework hours saved 14,000Customer support hours saved 850Hours of warranty repairs saved 8,000Fewer loads moved 225Additional unit sales of presses 140Contribution margin generated by

additional sales of presses $1,680,000

Required:1. Should SpeedPrint change to the new component?

Cost of change: $70 X 1 X 18,000 original sales level ($1,260,000)Advantages:

Additional CM generated through sales $1,680,000COQ Savings

Variable rework cost savings 1,106,000Variable customer support savings 29,750

Variable transportation savings 78,750

Variable warranty repair cost savings 712,000 $3,606,500Net advantage of changing component $2,346,500

2. Suppose the estimate of 140 additional presses sold is uncertain. Whatis the minimum number of additional presses that SpeedPrint needs tosell to justify adopting the new press?

Net advantage of changing component $2,346,500Additional CM generated through sales $1,680,000


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Additional TCM generated without additional sales $666,500

Thus no additional sales are needed.

Note: If additional sales had been needed:Additional TCM needed through additional sales (assumed) $1,000,000Since:

TCM generated from 140 units of additional sales = $1,680,000Additional CM expected per new unit sold ($1,680,000 / 140) 12,000

Additional unit sales needed to justify component change 83.33


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Exercise 19-29 Statistical quality controlGiven:Keltrex Cereals produces a wide variety of breakfast products. The company's three bestselling breakfast cereals are Double Bran Bits, Honey Wheat Squares, and Sugar King Pops.Each box of a particular type of cereal is required to meet pre-determined weight specifications,so that no single box contains more or less cereal than another. The company measures themean weight per production run to determine if there are variances over or under the company'sspecified upper and lower level control limits. A production run that falls outside of the specifiedcontrol limit does not meet quality standards and is investigated further by management todetermine the cause of the variance. The three Keltrex breakfast cereals had the followingweight standards and production run data for the month of March.

March results:Double Bran Bits Lower (1) Upper (2) Double Bran Bits

Production Std. Mean Weight 2-Sigma 2-Sigma Actual Mean Weight

Run # Per Production Run Control Limit Control Limit Per Production Run

1 17.97 17.41 18.53 18.232 17.97 17.41 18.53 18.143 17.97 17.41 18.53 18.224 17.97 17.41 18.53 18.30

5 17.97 17.41 18.53 18.106 17.97 17.41 18.53 18.057 17.97 17.41 18.53 17.848 17.97 17.41 18.53 17.669 17.97 17.41 18.53 17.6010 17.97 17.41 18.53 17.52

Std. Deviation 0.28(1)17.97 - (2)(.28) = 17.41(2)17.97 + (2)(.28) = 18.53

Honey Wheat Squares Lower (1) Upper (2) Honey Wheat SquaresProduction Std. Mean Weight 2-Sigma 2-Sigma Actual Mean Weight

Run # Per Production Run Control Limit Control Limit Per Production Run1 14 13.68 14.32 14.112 14 13.68 14.32 14.133 14 13.68 14.32 13.984 14 13.68 14.32 13.895 14 13.68 14.32 13.916 14 13.68 14.32 14.017 14 13.68 14.32 13.948 14 13.68 14.32 13.999 14 13.68 14.32 14.0310 14 13.68 14.32 13.97

Std. Deviation 0.16(1)14.00 - (2)(.16) = 13.68(2)14.00 + (2)(.16) = 14.32

Sugar King Pops Lower (1) Upper (2) Sugar King PopsProduction Std. Mean Weight 2-Sigma 2-Sigma Actual Mean Weight

Run # Per Production Run Control Limit Control Limit Per Production Run

1 16.02 15.60 16.44 15.832 16.02 15.60 16.44 16.113 16.02 15.60 16.44 16.244 16.02 15.60 16.44 15.695 16.02 15.60 16.44 15.95


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6 16.02 15.60 16.44 15.507 16.02 15.60 16.44 15.868 16.02 15.60 16.44 16.239 16.02 15.60 16.44 16.1510 16.02 15.60 16.44 16.60

Std. Deviation 0.21(1)16.02 - (2)(.21) = 15.60(2)16.02 + (2)(.21) = 16.44

Required:1. Using the 2-Sigma rule, what variance investigation decision would be made?

The 2-Sigma rule will trigger a decision to investigate whenever the actual mean weight of a

production run is outside of the control limits.

Upper: Mean + (2 X Std. Deviation)Lower: Mean - (2 X Std. Deviation)

The only runs with values outside the specified control limits were associated with theproduction of Sugar King Pops. Runs: 6 and 10

2. Present the Statistical Control Charts for each of the three breakfast cereals for

March. What inferences can be drawn from the charts?

See Chart 1, 2, and 3.

Chart 1: Double Bran Bits had no production run observations outside the control limits.However, there is an apparent trend observable from the statistical control chartwhich shows steady movement toward the lower control limit. This trend shouldbe investigated by management to learn if there is faulty equipment or an out ofcontrol process that will eventually result in under weighted cereal boxes.

Chart 2: Honey Wheat Squares has no observations outside of either control limts. Infact, the process appears to be in control. Variations appear to be random in

nature with no apparent trends that warrant further investigation.

Chart 3: Sugar King Pops has two observations outside the control limits. One falls belowthe lower control limit and one above the upper control limit. These two productionruns are not in conformance with quality standards. Management attention isneeded to determine the cause of the significant variances.

3. What are the costs of quality in this example?

Prevention Costs: Costs incurred to preclude the production of products that do not

conform to quality specifications. Examples include costs of designing the process,maintaining equipment, and employee training to properly operate the production line.

Appraisal Costs: Costs incurred to detect which of the individual units of products do

not conform to quality specifications. Examples include costs of inspections to checkweight of cereal boxes.

Internal Failure Costs: Costs incurred on a defective product before it is shipped to

customers. Examples include costs of refilling cereal boxes that do not meet specifications;costs to fix causes of failure such as machine calibration, material variability, or human

error; costs of reconfiguring manufacturing processes to prevent errors in filling cereal boxes.

External Failure Costs: Costs incurred on a defective product after being shipped to


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customers. Examples include costs of customer ill-will, costs of returning and replacing

incorrectly filled boxes.

How could Keltrex employ Six Sigma programs to improve quality?

Six Sigma quality is a standard of excellence that requires a strict understanding of bothcustomer expectations and reasons for manufacturing defects to improve current qualityperformance. The statistical term six sigma translates to 3.4 defects per 1 million incidents,or near perfection in quality variability. Key aspects of Six Sigma are to define, measure,analyze, improve and control processes.

Keltrex Cereals could employ Six Sigma programs to reduce variability in box weights. Thecompany would first need to define the quality problem (i.e. variability in weight per cerealbox), measure the incidents of defect using statistical quality control tools, analyze potentialreasons for variability in the weight per cereal box (machine calibration, material variability,human error, etc). Assuming, as an example, that the variability is due to machines thecompamy may choose to better calibrate the existing machines, purchase new machinesthat are more precise, or investigate other engineering alternatives. Finally, as improvementsare made to the existing machines, the company needs to monitor the improvements toensure that the variability problem has been resolved.


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16.8

17

17.2

17.4

17.6

17.8

18

18.2

18.4

18.6

18.8

1 2 3 4 5 6 7

Statistical Control Chart

Double Bran Bits

for the Month of March

Standard Mean Weight (Ounces) Lower Control Weight Upper Control Limit A


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8 9 10

ctual Mean Weight Per Production Run


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13.2

13.4

13.6

13.8

14

14.2

14.4

1 2 3 4 5 6 7

Statistical

Control Chart for

Honey Wheat Squares for March

Standard Mean Weight (Ounces) Lower Control Limit Upper Control Limit


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8 9 10

Actual Mean Weight Per Production Run


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14.8

15

15.2

15.4

15.6

15.8

16

16.2

16.4

16.6

16.8

1 2 3 4 5 6 7

Statistical Control Chart

Sugar King Pops

March

Standard Mean Weight Lower Control Limit Upper Control Limit Ac


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8 9 10

tual Mean Weight Per Production Run


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Investigate or not investigateGiven:You are the manager of a manufacturing process. A significant material efficiency

variance of $10,000 has been reported for the week's operations. The magnitudeof the variance falls outside of the upper control limit of a statistical control diagram.You are trying to decide whether to investigate this variance. You feel that if you do

not investigate and the process is out of control, the present value of the cost savingsforegone over the planning horizon is $3,800. The cost to investigate is $500. Thecost per period of being out of control is $700. If an out-of-control process isdiscovered, the cost of correcting it is $300. You assess the probability that theprocess is out of control at 30%.

Required:1. Should the process be investigated? What are the expected costs of

investigating and of not investigating?

Actions In Control Out of Control EMV of the

Probability of the state of nature 0.70 0.30 Decision

Investigate the process (and fix if necessary) ($500) ($1,500) ($800)Do not investigate the process $0 ($3,800) ($1,140)

Decision: Investigate

2. At what level of probability that the process is out of control would theexpected costs of each action be the same?

In Control Out of Control EMV of the

Probability of the state of nature X 1-X Decision

Investigate the process (and fix if necessary) ($500) ($1,500) #VALUE!

Do not investigate the process $0 ($3,800) #VALUE!

EMV of Investigate: ($500)(X) +(1-X)($1,500) =EMV of Do Not Investigate: ($0)(X) + (1-X)($3,800) =Point of Indifference $500(X)+$1,500-$1,500(X) = $3,800-$3,800(X)

$-1,000(X) +$1,500 = $3,800 - $3,800(X)$2,800(X) = $2,300X = $2,300/$2,800 = 0.821428571(1-X) = 0.178571429

Proof:

In Control Out of Control EMV of the

Probability of the state of nature 0.821428571 0.178571429 Decision

Investigate the process (and fix if necessary) ($500) ($1,500) ($679)Do not investigate the process $0 ($3,800) ($679)

3. If the cost variance is $10,000, why is the cost savings foregone over theplanning horizon $3,800?

The $10,000 is the absolute size of the materials efficiency variance. Perhapsthe plant manager has already taken steps to prevent continued incurrence of the

variance (such as requiring suppliers to check more thoroughly the quality of their

State of Nature

State of Nature

State of Nature


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materials). This action would reduce the magnitude of subsequent materialsefficiency variances. Alternatively, a large chunk of the variance may be a randomdeviation. If so, it would be impossible to count on saving the full amount even if

the process is out of control.


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Exercise 19-25 Theory of ConstraintsGiven:The Mayfield Corporation manufactures filing cabinets in two operations: machining

and finishing.Machining Finishing

Annual capacity (units) 100,000 80,000

Annual production (units) 80,000 80,000Fixed operating costs (excluding DM) $640,000 $400,000Fixed operating costs per unit produced $8 $5

Each cabinet sells for $72Variable costs (all direct materials; added at the beg. of machining) $32Demand is unlimited (Can sell all it can produce.)

Required:1. Mayfield is considering using some modern jigs and tools in the finishing

operation that would increase annual finishing output by 1,000 units. Theannual cost of these jigs and tools is $30,000. Should Mayfield acquire

these tools?

Finishing is a bottleneck.

Modern jigs and tools would relax the bottleneck by 1,000 units.Benefit of modern jigs and tools:

Additional contribution margin generated $40,000Incremental fixed costs associated with tools (30,000)

Net advantage of buying modern jigs and tools $10,000

Recommendation: Buy modern jigs and tools

2. The production manager of the Machining Department has submitted aproposal to do faster setups that would increase the annual capacity ofthe Machining Department by 10,000 units and cost $5,000 per year.Should Mayfield implement the change?

Machining already has excess capacity and is therefore not a bottleneckoperation. Increasing its capacity further will not increase throughput contribution.

Therefore, there is no benefit from spending $5,000 to increase the MachiningDepartment's capacity by 10,000 units.

Recommendation: Do not implement the change to do faster setups.

3. An outside contractor offers to do the finishing operation for 12,000 units

at $10 per unit, double the $5 per unit that it costs Mayfield to do the finishingin-house. Should Mayfield accept the subcontractor's offer?

Finishing is a bottleneck operation.Accepting the outside contractor's offer will increase output by 12,000 units.Advantage of accepting

Additional Throughput CM from increased sales $480,000Cost of outside finishing (120,000)

Net advantage of accepting the offer $360,000


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Recommendation: Accept the offer.

4. The Hunt Corporation offers to machine 4,000 units at $4 per unit, half the $8

per unit that it costs Mayfield to do the machining in-house. Should Mayfieldaccept the subcontractor's offer?

If Mayfield provides the materials to be converted, there is no variable cost savingsby accepting Hunt Corporation's offer. All other costs incurred by Mayfield are fixed.Therefore, there is no cost savings by accepting the Hunt offer. In addition, sincethe machining department is not a bottleneck, no additional throughput contributionwill be generated by accepting the offer from Hunt Corporation. Sales is limited by

the capacity of the finishing department. If the offer is accepted, costs will increaseby 4,000 X $4 = $16,000.

Recommendation: Reject the Hunt offer.

Exercise 19-26

Required:1. Mayfield produces 2,000 defective units during the machining operation. What isthe cost to Mayfield of the defective items produced?

Machining is not a bottleneck operation.Producing 2,000 defective units does not reduce throughput contribution; machiningcan still produce and transfer 80,000 good units to finishing.Therefore, the cost of the defective units is $32 X 2,000 = $64,000.

2. Mayfield produces 2,000 defective units at the finishing operation. What isthe cost to Mayfield of the defective items produced?

Finishing is a bottleneck operation.

Producing 2,000 defective units in the bottleneck operation will reduce throughputcontribution.Therefore, the cost of the defective units is

Lost materials added in the machining department 2,000 X $32 = $64,000Lost throughput contribution in finishing department 2,000 X ($72-$32)= 80,000

Total cost of the 2,000 defective units $144,000

Another approach: No Defects 2,000 Defects

Revenue from units sold $5,760,000 $5,616,000

Cost of units sold (includes spoiled units, if any) ** $2,560,000 $2,560,000

Gross profit $3,200,000 $3,056,000

Total cost of the 2,000 defective units $144,000

** Note that the direct material cost is irrelevant; whether the units are defective or goodthe direct material costs will be incurred.

Alternative calculation: 2,000 X $72 = $144,000


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$144,000


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Exercise 19-31 Waiting times, manufacturing cycle timesGiven:The Seawall Corporation uses an injection molding machine to make a plastic product, Z39.

Seawall manufactures only after an order is received. Average annual orders expected 50 Expected machine hours required per order 80

Annual machine capacity in machine hours 5,000Definitions:

AMLT = Average manufacturing lead timeAOWT = Average order wait timeAOMT = Average order manufacturing timeAMLT = AOWT + AOMT

Required:1. Calculate

a. The average amount of time that an order for Z39 will wait in line before it isprocessed

AOWT = (Average Annual Orders Expected) X (AOMT) X (AOMT)2 X (Annual Mach. Capacity - (Average Annual Orders Expected X AOMT))

AOWT = (50) X (80) X (80)

2 X (5,000 - (50 X 80))

AOWT = 320,000 / (2 X (5,000 - 4,000))

AOWT = 320,000

2,000

AOWT = 160 hours per order

b. The average manufacturing lead time per order for Z39.

AMLT = AOWT + AOMT

AMLT = 160 + 80 = 240 hours

2. Seawall is considering introducing a new product, Y28. Seawall estimates that,on average, it will receive 25 orders of Y28 in the coming year. Each order of

Y28 will take 20 hours of machine time. The average demand for Z39 will be

unaffected by the introduction of of Y28.

Calculate

a. The average waiting time for an order received and

AOWT = (Average Annual Orders of Z39) X (AOMT) X (AOMT) + ( Average Annual Orders of Y28) X (AOMT) X (AOMT)

2 X [Annual Mach. Capacity - [(Annual orders expected Z39 X AOMT)] - [(Annual orders expected Y28) X (AOM

AOWT = (50 X 80 X 80) + (25 X 20 X 20)

2 X [(5,000 - (50 X 80) - (25 X 20))]

AOWT = 330,000


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1,000

AOWT = 330 hours

b. The average manufacturing lead time per order for each product, if Seawallintroduces Y28.

Z39AMLT = AOWT + AOMT = 330 + 80 = 410 hours

Y28AMLT = AOWT + AOMT = 330 + 20 = 350 hours

Exercise 19-32 Waiting times, relevant revenues, and relevant costsGiven:Seawall is still debating whether it should introduce Y28. The following table providesinformation on selling prices, variable costs, and inventory carrying costs for Z39 and Y28.Seawall will incur additional variable costs and inventory carrying costs for Y28 only if it

introduces Y28. Z39 Y28

Annual average number of orders 50 25Average Manfucturing Lead Time (AMLT)

Produce only Z39 (from P19-31) 240 N/AProduce both Z39 and Y28 (from P19-31) 410 350

Average SP per order if AMLT per order isless than 320 hours $27,000 $8,400more than 320 hours $26,500 $8,000

Variable cost per order $15,000 $5,000Inventory carrying cost per order per hour $0.75 $0.25

Required:

1. Should Seawall manufacture and sell Y28.

Total Revenue /Cost Approach Do Not RelevantProduce Produce Revenues

Y28 Y28 Costs

Expected revenues50 X $27,000 Z39 $1,350,00050 X $26,500 Z39 $1,325,00025 X $8,000 Y28 200,000

Total Revenues $1,350,000 $1,525,000 $175,000

Expected variable costs50 X $15,000 Z39 $750,000 $750,000

25 X $5,000 Y28 125,000Total VC $750,000 $875,000 $125,000

Expected carrying costs

50 X $.75 X 240 Z39 $9,00050 X $.75 X 410 $15,375.0025 X $.25 X 350 Y28 $2,187.50

Total Carrying Costs $9,000 $17,562.50 $8,562.50

Expected Revenues less Costs $591,000 $632,437.50 $41,437.50


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Net benefit of producing Y28 $41,437.50

Recommendation: Produce and sell Y28.

2. Should Seawall manufacture and sell Y28. Given changes indicated below.

Z39 Y28Annual average number of orders 50 25Average SP per order if AMLT per order is

less than 320 hours $27,000 $6,400more than 320 hours $26,500 $6,000

Variable cost per order $15,000 $5,000Inventory carrying cost per order per hour $0.75 $0.25

Total Revenue /Cost Approach Do Not RelevantProduce Produce Revenues

Y28 Y28 Costs

Expected revenues

50 X $27,000 Z39 $1,350,00050 X $26,500 Z39 $1,325,00025 X $6,000 Y28 $150,000

Total Revenues $1,350,000 $1,475,000 $125,000

Expected variable costs

50 X $15,000 Z39 $750,000 $750,00025 X $5,000 Y28 125,000

Total VC $750,000 $875,000 $125,000

Expected carrying costs

50 X $.75 X 240 Z39 $9,00050 X $.75 X 410 $15,375.0025 X $.25 X 350 Y28 $2,187.50

Total Carrying Costs $9,000 $17,562.50 $8,562.50Expected Revenues less Costs $591,000 $582,437.50 ($8,562.50)

Net benefit of producing Y28 ($8,562.50)

Recommendation: Do not produce and sell Y28.

Note: Total revenues decrease by $50,000, therefore difference between Q1and Q2 is a decrease of $50,000.

($8,562.50)


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T)]]


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Exercise 19-17Definitions:

Prevention Costs: Costs incurred to preclude the production of products

that do not conform to quality specifications.Appraisal Costs: Costs incurred to detect which of the individual units of

products do not conform to quality specifications.

Internal Failure Costs: Costs incurred on a defective product before it isshipped to customers.External Failure Costs: Costs incurred on a defective product after it is

shipped to customers.

Required:1. Classify the cost items into prevention, appraisal, internal failure, or external

failure categories.2. Calculate the ratio of each COQ category to revenues in 2007 and 2008. Comment

on the trends in costs of quality between 2007 and 2008.

2007 2007 2008 2008

Annual Revenue $20,000,000 $25,000,000Prevention Costs: Dollars Percentages Dollars Percentages

Design Engineering $210,000 1.05% $600,000 2.40%Preventive equipment maintenance 110,000 0.55% 200,000 0.80%Supplier evaluation 80,000 0.40% 200,000 0.80%

Total prevention costs $400,000 2.00% $1,000,000 4.00%

Appraisal Costs:Inspection of production $220,000 1.10% $170,000 0.68%Product-testing labor & equipment 530,000 2.65% 250,000 1.00%Incoming material inspection 50,000 0.25% 80,000 0.32%

Total appraisal costs $800,000 4.00% $500,000 2.00%

Internal Failure Costs:

Scrap & rework $720,000 3.60% $670,000 2.68%Breakdown maintenance 180,000 0.90% 80,000 0.32%

Total Internal failure costs $900,000 4.50% $750,000 3.00%

External Failure Costs:Returned goods $120,000 0.60% $300,000 1.20%Customer support 80,000 0.40% 65,000 0.26%Warranty repair 1,000,000 5.00% 635,000 2.54%

Total external failure costs $1,200,000 6.00% $1,000,000 4.00%

Total Quality Costs: $3,300,000 16.50% $3,250,000 13.00%

16.50% 13.00%

Between 2007 and 2008, the company's COQ declined from 16.50% to 13.00% of sales.

Analysis of individual COQ categories indicates that the company began allocating moreresources to prevention activities in 2008 relative to 2007. As a result, appraisal costs,internal failure costs, and external failure costs declined in 2008.

However, management should investigate the reasons why the cost of returned goodsincreased and initiate corrrective action where appropriate.

3. Give two examples of nonfinancial quality measures that the company could monitor in its


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balanced scorecard as part of a total quality-control effort.

Examples

# of defective units shipped to customers as a % of total units shipped.Ratio of good output to total output at each production process.Employee turnover

Customer satisfaction surveys


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Exercise 19-19Given:Eastern Switching Co. (ESC) produces telecommunications equipment.

The following information is available for the first year (2007) of ESC'sTQM program.

2006 2007

(No TQM) (New TQM)Total # of units produced and shipped 10,000 11,000Units delivered before or on scheduled delivery date 8,500 9,900Number of defective units shipped 400 330Customer complaints other than for defective units 500 517Average time from order placement to delivery (in days) 30 25Number of units reworked during production 600 627Manufacturing lead time (in days) 20 16Direct and indirect manufacturing labor-hours 90,000 110,000

Required:1. For each of the years 2006 and 2007 calculate: 2006 2007

a. % of defective units shipped 4.00% 3.00%b. On-tine delivery rate 85.00% 90.00%c. Customer complaints as a % of units shipped 5.00% 4.70%d. % of units reworked during production 6.00% 5.70%

2. On the basis of your calculations in requirement 1, has ESC'sperformance on quality and timeliness improved?

The calculations in requirement #1 indicate:

Quality has improved becausea. % of defective units shipped decreasedb. Customer complaints as a % of units shipped have decreasedc. % of units reworked during production has decreased

Timeliness has improved as on-time delivery has increased. Better quality

and less rework reduces delays in production and enables shorter lead times andenables on-time delivery to customers.

3. Philip Larken, a member of ESC's board of directors, comments thatregardless of the effect that the TQM program has had on quality, theoutput per labor-hour has declined between 2006 and 2007. Larkinbelieves that lower output per labor-hour will lead to an increase in costsand lower operating income.a. How did Larkin conclude that output per labor-hour declined in 2007

relative to 2006?2006 2007

Output per labor-hour 0.11 0.10

b. Why might output per labor-hour decline in 2007?

Output per labor-hour may have declined from 2006 to 2007 either becauseworkers were less productive or more likely because the initial implementation

of the quality program may have resulted in lost production time as employeeswere trained and became more adept at solving production quality problems.


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As workers implement good quality practices and defects and rework decreaseover time, it is possible that both quality and productivity (output per labor-hour)will increase.

c. Do you think that a lower output per labor-hour will decrease operatingincome in 2007? Explain.

It is not clear that the lower output per labor-hour will decrease operating incomein 2007. The higher labor costs in 2007 could pay off in many ways. Higher qualityand lower defects will likely result in lower material costs because of lower defectsand rework. Internal and external failure costs will also be lower, resulting in lowercustomer returns and warranty costs.

Customer satisfaction will likely increase, resulting in higher sales, higher prices,

and higher contribution margins. The 10% increase in the number of units producedand sold in 2007 may well have been due to quality improvements. Overall, thebenefits of higher quality in 2007 may very well exceed the higher labor costs per unitof output.


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Exercise 19-29Given:Jetrans Airlines operates daily round-trip flights on the London-Los Angeles route using a fleet

of three 747s; the Spirit of Atlanta, the Spirit of Boston, and the Spirit of Sacramento.

The budgeted quantity of fuel for each round-trip flight is the 12-month mean (average) round-

trip fuel consumption of 200 gallon-units, with a standard deviation of 20 gallon-units. A gallon-unit is 1,000 gallons.

Using a statistical quality control (SQC) approach, Shirly Watson, the Jetrans operationsmanager, investigates any round-trip with fuel consumption that is greater than 2 standarddeviations from the mean.

October results: Spirit of Spirit of Spirit of

Mean Lower (1) Upper (2) Atlanta Boston SacramentoFlight Fuel Usage 2-Sigma 2-Sigma Fuel Usage Fuel Usage Fuel Usage

Number Per Flight Control Limit Control Limit Gallon-Units Gallon-Units Gallon-Units

1 200 160 240 208 206 194

2 200 160 240 187 188 2083 200 160 240 194 192 2214 200 160 240 202 214 2085 200 160 240 211 184 2426 200 160 240 215 226 2347 200 160 240 216 198 2498 200 160 240 218 212 2279 200 160 240 221 202 23210 200 160 240 232 186 244

(1)200 - (2)(20) = 160(2)200 + (2)(20) = 240

Required:

1. Using the 2-Sigma rule, what variance investigation decision would be made?The 2-Sigma rule will trigger a decision to investigate whenever the round-trip fuel usageis outside of the control limits.

Upper: Mean + (2 X Std. Deviation) = 200 + (2 X 20) = 200 + 40 = 240Lower: Mean - (2 X Std. Deviation) = 200 - (2 X 20) = 200 - 40 = 160

The only plane to be outside the specified control limits is the Spirit of Sacramento.See red values above -- flights 5, 7, 10.

2. Present the Statistical Control Charts for round-trip fuel usage for each of thethree 747s in October. What inferences can be drawn from the charts?

See Chart 1, 2, and 3.

Chart 1: The Spirit of Atlanta has no observations outside either control limit.However, there was an increase in fuel use in each of the last 9 round-tripflights. The probability of 9 consecutive increases from an in-control processis very low. This is a trend that should be investigated.

Chart 2: The Spirit of Boston appears to be in control regarding fuel usage.


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Chart 3: The Spirit of Sacramento has 3 observations outside the upper control limit.Moreover, the last 6 flights have been hovering close to the upper control

limit. This is unlikely for an in-control operation.

3. Some managers propose that Jetrans Airlines present its quality control chart

in monetary terms rather than in physical-quantity terms (gallon-units). Whatare the advantages and disadvantages of using monetary fuel costs rather than

gallon-units in the SQC charts?

Advantage:Focuses on a variable of overriding concern to top managers -- operating costs ($)

Disadvantages:

Split responsibilities. Operations managers may not control the purchase of fuel, and therefore may want to exclude from their performance measures any variation stemming from factors

outside their control.

Offsetting factors may mask important underlying trends when the quantity usedand the price paid are combined in a single observation. For example, decreasing gallon usage may be offset by increasing fuel costs. Both of these individual patterns are important in budgeting for an airline.

The distribution of fuel usage in gallons may be different from the distributionof fuel prices per gallon. More reliable estimates of the mean and standarddeviation parameters might be obtained by focusing separately on the individual

usage and price distributions.

Note: The above disadvantages are most marked if actual fuel prices are used.

The use of standard fuel prices can reduce many of these disadvantages.


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0

50

100

150

200

250

300

1 2 3 4 5 6 7 8 9 10

Gallon-Units

Flight Number

Spirit of Atlanta 2-Sigma SCC for Fuel Consumption Expressed in Gallon-Units

Series1

Series2

Series3

Series4


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0

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100

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1 2 3 4 5 6 7 8 9 10

Gallon-Units

Flight Number

Spirit of Boston 2-Sigma SCC for Fuel Consumption Expressed in Gallon Units

Series1

Series2

Series3

Series4


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0

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200

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Gallon-Units

Flight Number

Spirit of Sacramento 2-Sigma SCC for Fuel Consumption Expressed in Gallon-Units


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Exercise 19-35Given:Aardee Industries manufactures pharmaceutical products in two departments:

TabletMixing Making

Measurement units grams tablets

Capacity per hour (grams; tablets) 150 200Monthly capacity (2,000 hours available per department) 300,000 400,000Monthly production of good units 200,000 390,000Fixed operating costs $16,000 $39,000Fixed operating costs per unit (grams; tablets) $0.08 $0.10DM costs; all incurred in the Mixing Department $156,000% of the DM mixture lost in the tablet-making process 2.50%Grams of DMs needed per tablet 0.50Selling price per tablet $1All costs other than DM dollars are fixed

The Mixing Department makes 200,000grams of DM mixture (enough to make

400,000 tablets) because the Tablet-Making Department has only enough capacityto process 400,000 tablets.

Required:

1. If Aardee will supply a contractor with 10,000 grams of mixture, the contractorwill manufacture 19,500 tablets for Aardee (allowing for the normal 2.5% lossduring the tablet-making process) at $.12 per tablet. Should Aardee acceptthe contractor's offer? 19,500

Tablet-making is a bottleneck-- supplying the DM mixture and paying for external

tablet processing will generate additional throughput contribution ofSelling price per tablet $1DM costs per tablet 0.40Outside contracting cost per tablet 0.12

Throughput contribution per tablet purchased $0.48

Benefit if Aardee accepts the outside contractor's offer $9,360

2. Another company offers to prepare 20,000 grams of mixture a month fromDM that Aardee supplies. The company will charge $.07 per gram of mixture.Should Aardee accept the company's offer?

The mixing operation is not a bottleneck.Buying extra mixture will not increase throughput contribution or decrease thecost of obtaining the mixture since the mixing operations has no avoidable costs.

Recommendation: Reject the offer.

3. Aardee's engineers have devised a method that would improve quality in thetablet-making operation. They estimate that the 10,000 tablets currently being

lost would be saved. The modifications would cost $7,000 a month.Should Aardee implement the new method?

Tablet-making is a bottleneck operation.


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The quality program will increase sales revenue by (no change in VC) $10,000Monthly incremental cost of the quality program 7,000

Advange of the modifications $3,000

Recommendation: Implement the new methods

4. Suppose that Aardee also loses 10,000 grams of mixture in its mixing operation.These losses can be reduced to zero if the company is willing to spend $9,000per month in quality-improvement methods.

Should Aardee adopt the quality-improvement method?

Cost savings from quality programs (cost of previously lost mixture) $7,800Cost of the quality program 9,000

Disadvantage of the quality-improvement ($1,200)

Recommendation: Do not Implement the new quality-improvement method.

5. What are the benefits of improving quality at the mixing operation compared with

improving quality at the tablet-making operation?

The benefit of improving quality of the mixing operation is the savings in materials costs

less the cost of the improvement program.

The benefit of improving quality of the tablet-making operation (the bottleneck operation)

is the increased sales revenue less the cost of the improvement program.

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