Cost-benefit analysis is a simple technique for deciding whether a change is to be brought in any production process or it may be applied to any situation where costs are involved to obtain financial benefits. In a cost-benefit analysis, only financial costs and financial benefits are taken into account. In a cost-benefit analysis, all the positive factors are found, quantified, and added and these represent the benefits. It also identifies, quantifies, and subtracts the negative factors representing the costs. The difference between the positive and negative factors indicates whether the planned action is advisable.
The cost-benefit can be considered in three scenarios:
Scenario I – The Company inspects 18,000 lots to keep the inspection costs within $ 1,000,000
In the instant case, by solving the case for the number of defectives to be inspected it is found that out of the 20,000 lots proposed to be made, 18,000 lots need to be inspected to arrive at a defective quantity of 300 lots. This defective quantity is arrived at by solving for the ‘X value in the Excel sheet. The inspection of 18,000 units will keep the inspection costs within the proposed level of $ 1,000,000.
The total cost of inspection in this scenario is as follows:
Cost of 300 Defective lots 300 X 100 X $ 33.3333 = $ 1,000,000
Cost of inspecting 18,000 lots 18,000 X $ 500 = $ 9,000,000
Total cost to the company $ 9,000,000 + $ 1,000,000 = $ 10,000,000
Scenario II – The Company does not do any inspection
There is no inspection cost involved.
Cost of defective items would be 20000 X 0.15 X 100 X 33.3333 = $ 10,000,000
Scenario III –The Company does 100 percent Inspection
From the simulation process (done in Excel), it is found that the cost of defective units and cost of inspection remains the same irrespective of the fact that the Company inspects 1 unit or 20,000 units. There is no change in the cost. In this case, there will be no defective units. However the inspection cost remains at 20,000 X $ 500 = $ 10,000,000
Quality Policy
Even though all three scenarios may involve a total cost of $ 10,000,000, the cost-benefit analysis leads to different results. Considering the financial involvements in the above three scenarios, to meet the condition that the inspection charges should be less than or equal to 1% of the total sales value, the Company should adopt a quality policy of inspecting 18,000 units as shown in scenario one.