Posted: July 12th, 2016

# State the amount of the current cost of external failures?

An insurance company has the following profitability analysis of its services. There are no services or divisions other than what is stated below:
……………………………..Life Insurance…………Auto Insurance…………Home Insurance
Revenues…………………\$5,000,000…………….\$10,000,000……………..\$3,000,000
Commissions…………….(1,000,000)……………..(2,000,000)……………….(600,000)
Claims/Payments……….(3,000,000)……………..(7,300,000)………………(2,000,000)
Fixed Costs………………..(500,000)………………..(500,000)………………..(500,000)
Profit…………………………\$ 500,000………………..\$200,000……………….(\$100,000)

The fixed costs are distributed equally among the services and are not avoidable if one of the services is dropped.
Determine next year’s profitability for the company if all services with losses are dropped and if all other revenues and expenses remain unchanged from the current year.

A company is considering additional final inspection costs of \$1 per unit before delivery to customers. It currently delivers 60,000 units per year. The additional inspection should reduce the defective rate from 3 percent to 1 percent. If a defective unit is found, it is scrapped at no additional cost. The manufacturing costs before the final inspection are \$200 per unit. The management believes that the external failure costs are \$40 per defective unit.

a. State the amount of the current cost of external failures.
b. Should the management incur the additional inspection costs? Why or why not?

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