Reference no: EM132292523

Jerry is the CEO of XYZ Motors, a large automotive company that produces affordable four-passenger cars for the typical lower-income class family. Each model is typically driven only five years. The model from two years ago, the XYZ-8, which sold for $8,000, has been involved in four car crashes where the cars, when struck from the rear when the right blinker signal is activated, causes the fuel in the gas tank to ignite.  There have been no fatalities, but several injuries. Victims have begun organizing into a class action lawsuit against the company.  

A technician at the company discovered the issue with the blinker circuit soon after the last explosion was analyzed. He wrote the following memo to his superiors:

“We can recall each of the XYZ-8 models that we have sold and replace the blinker circuit with a new lining.  It is highly likelythis will correct the issue.  This will lead to a cost to the company of $20 per car for the repair and an estimated $50 in lost labor revenues, since we cannot charge for the refit. There are an estimated 500,000 cars that are affected.  Estimated cost to the company of this refit program:  $35 million.  If we do not act soon, there could be an estimated two explosions per year.”  

Soon after reading this memo, Jerry gives his accounting department a hypothetical scenario: what would be the cost of settling a class action lawsuit out of court for ten low-income families? Estimating the present value of typical future earnings from a blue collar worker, aged 18 to retirement age of 65, the accountant gives a figure of $600,000 per family, amounting to a total settlement of $6 million.

Jerry orders his legal counsel to proceed with settling the class action lawsuit and does not inform his board of directors about the technician’s memo. Discuss.