Reference no: EM132279821
A pharmaceutical company manufactured a prescription drug that contained a tablet inside another tablet. This inner tablet, called a “core”, needed to be in the exact center of the larger tablet, and tolerances were measured in tenths of millimeters. The process was not robust, and the placement of the inner tablet sometimes drifted, requiring the scrapping of off-quality product and the adjustment of the tablet press. This resulted in significant scrap and tablet press downtime.
A process change was invented in Japan to correct the problem, using a new process to place the inner tablet in the die of the press that made the outer tablet. There were three of these tablet presses in use in the U.S., but modifications were made to one tablet press as a test. The modification to the first press cost $27,000. During the first batch the modified press ran the entire batch without a quality problem and without quality losses. The batch finished compressing in 16 hours, which was considerably faster than the typical time of 24 hours (however, core centering problems could cause a delay of several days).
Additional test batches were run, all with excellent results. A detailed quality examination proved that the modification performed as desired, reducing variation and nearly eliminating product scrap. The other two tablet presses were later modified. The total cost for all modifications, including spare parts, was $90,000.
Over the next year, the results of the change were analyzed. Product yield increased from 92.4% to 96.5%. Because less of the expensive active drug was scrapped and instead became good product, each 1% increase in yield was valued at $2.4 million per year. Operating efficiency improved, resulting in higher output because of less scrap and less downtime due to quality problems. Production plans called for 240 batches to be processed over the year after the tablet press modification was made. This product was produced daily, but production was reduced from three shifts to two because of improved efficiency. Production planning could not plan effectively; they knew that a batch could be processed in two shifts, not one to five days.
Year-end accounting showed $10 million saved in the first year. Because the product’s patent was about to expire, production was expected to be greatly reduced beyond this time.
1. One year of production had a value of $240 million. What is the value of one batch of product?
2. How many batches needed to be produced to break even on the initial $27,000 investment? (Assume all batches improved the yield by 4.2%. Do not consider the time value of money.)
3. If the first-year savings is considered to be a single end-of-year cash flow, and the entire $90,000 investment is considered to occur at time 0, what is the present value of the project? Assume an interest rate of 15%.
4. If one batch is produced per day, how often are the savings actually compounded?
5. Does a company face any ethical considerations when it improves process efficiency resulting in lost labor hours for employees?