COMPARING PREVENTIVE AND BREAKDOWN MAINTENANCE COSTS. Farlen & Halikman is a CPA firm specializing in payroll preparation. The firm has been successful in automating much of its work, using high-speed printers for check processing and report preparation. The computerized approach, however, has

Question

COMPARING PREVENTIVE AND BREAKDOWN MAINTENANCE COSTS. Farlen & Halikman is a CPA firm specializing in payroll preparation. The firm has been successful in automating much of its work, using high-speed printers for check processing and report preparation. The computerized approach, however, has problems. Over the past 20 months, the printers have broken down at the rate indicated in the following table:

NUMBER OF BREAKDOWNS	NUMBER OF MONTHS THAT BREAKDOWNS OCCURRED
0	2
1	8
2	6
3	4
	Total: 20

Each time the printers break down, Farlen & Halikman estimates that it loses an average of $300 in production time and service expenses. One alternative is to purchase a service contract for preventive maintenance. Even if Farlen & Halikman contracts for preventive maintenance, there will still be breakdowns, averaging one breakdown per month. The price for this service is $150 per month.

APPROACH [latex]\blacktriangleright[/latex] To determine if the CPA firm should follow a “run until breakdown” policy or contract for preventive maintenance, we follow a 4-step process:
Step 1 Compute the expected number of breakdowns (based on past history) if the firm continues as is, without the service contract.
Step 2 Compute the expected breakdown cost per month with no preventive maintenance contract.
Step 3 Compute the cost of preventive maintenance.
Step 4 Compare the two options and select the one that will cost less.

Accepted Answer

SOLUTION [latex]\blacktriangleright[/latex]
Step 1

NUMBER OF BREAKDOWNS	FREQUENCY	NUMBER OF BREAKDOWNS	FREQUENCY
0	2/20 = .1	2	6/20 = 0.3
1	8/20 = .4	3	4/20 = 0.2

[latex]\left(\begin{matrix} Expected number \ of breakdowns\end{matrix} ight) = \sum {\left[\left(\begin{matrix} Number of \ breakdowns\end{matrix} ight) imes \left(\begin{matrix}Corresponding \ frequency\end{matrix} ight) ight]}[/latex]
= (0)(.1) + (1)(.4) + (2)(.3) + (3)(.2)
= 0 + .4 + .6 + .6
= 1.6 breakdowns/month

Step 2
Expected breakdown cost = [latex]\left(\begin{matrix} Expected number \ of breakdowns\end{matrix} ight) × \left(\begin{matrix} Cost per \ breakdown\end{matrix} ight)[/latex] = (1.6)($300) = $480/month

Step 3
[latex]\left(\begin{matrix} Preventive \ maintenance cost\end{matrix} ight) = \left(\begin{matrix} Cost of expected \ breakdowns if service \ contract signed\end{matrix} ight) + \left(\begin{matrix} Cost of \ service contract\end{matrix} ight)[/latex] = (1 breakdown/month)($300) + $150/month = $450/month

Step 4 Because it is less expensive overall to hire a maintenance service firm ($450) than to not do so ($480), Farlen & Halikman should hire the service firm.

INSIGHT [latex]\blacktriangleright[/latex] Determining the expected number of breakdowns for each option is crucial to making a good decision. This typically requires good maintenance records.

LEARNING EXERCISE [latex]\blacktriangleright[/latex] What is the best decision if the preventive maintenance contract cost increases to $195 per month? [Answer: At $495 (= $300 + $195) per month, “run until breakdown” becomes less expensive (assuming that all costs are included in the $300 per breakdown cost).]
RELATED PROBLEMS [latex]\blacktriangleright[/latex] 17.18–17.21 (17.22–17.24 are available in MyOMLab)

Question 17.EX.5: COMPARING PREVENTIVE AND BREAKDOWN MAINTENANCE COSTS. Farlen...

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