Case 1: Zip Zap Zoom Car Company
Zip Zap Zoom Company Ltd is into manufacturing cars in the small car (800 cc) segment. It was set up 15 years back and since its establishment it has seen a phenomenal growth in both its market and profitability. Its financial statements are shown in Exhibits 1 and 2 respectively.
The company enjoys the confidence of its shareholders who have been rewarded with growing dividends year after year. Last year, the company had announced 20 per cent dividend, which was the highest in the automobile sector. The company has never defaulted on its loan payments and enjoys a favorable face with its lenders, which include financial institutions, commercial banks and debenture holders.
The competition in the car industry has increased in the past few years and the company foresees further intensification of competition with the entry of several foreign car manufactures many of them being market leaders in their respective countries. The small car segment especially, will witness entry of foreign majors in the near future, with latest technology being offered to the Indian customer. The Zip Zap Zoom’s senior management realizes the need for large scale investment in up gradation of technology and improvement of manufacturing facilities to pre-empt competition.
Whereas on the one hand, the competition in the car industry has been intensifying, on the other hand, there has been a slowdown in the Indian economy, which has not only reduced the demand for cars, but has also led to adoption of price cutting strategies by various car manufactures. The industry indicators predict that the economy is gradually slipping into recession.
Exhibit 1 Balance sheet as at March 31,200 x
(Amount in Rs. Crore)
Source of Funds
Share capital 350
Reserves and surplus 250 600
Loans :
Debentures (@ 14%) 50
Institutional borrowing (@ 10%) 100
Commercial loans (@ 12%) 250
Total debt 400
Current liabilities 200
1,200
Application of Funds
Fixed Assets
Gross block 1,000
Less : Depreciation 250
Net block 750
Capital WIP 190
Total Fixed Assets 940
Current assets :
Inventory 200
Sundry debtors 40
Cash and bank balance 10
Other current assets 10
Total current assets 260
-1200
Exhibit 2 Profit and Loss Account for the year ended March 31, 200x
(Amount in Rs. Crore)
Sales revenue (80,000 units x Rs. 2,50,000) 2,000.0
Operating expenditure :
Variable cost :
Raw material and manufacturing expenses 1,300.0
Variable overheads 100.0
Total 1,400.0
Fixed cost :
R & D 20.0
Marketing and advertising 25.0
Depreciation 250.0
Personnel 70.0
Total 365.0
Total operating expenditure 1,765.0
Operating profits (EBIT) 235.0
Financial expense :
Interest on debentures 7.7
Interest on institutional borrowings 11.0
Interest on commercial loan 33.0 51.7
Earnings before tax (EBT) 183.3
Tax (@ 35%) 64.2
Earnings after tax (EAT) 119.1
Dividends 70.0
Debt redemption (sinking fund obligation)** 40.0
Contribution to reserves and surplus 9.1
* Includes the cost of inventory and work in process (W.P) which is dependent on demand (sales).
** The loans have to be retired in the next ten years and the firm redeems Rs. 40 crore every year.
The company is faced with the problem of deciding how much to invest in up
gradation of its plans and technology. Capital investment up to a maximum of Rs. 100
crore is required. The problem areas are three-fold.
- The company cannot forgo the capital investment as that could lead to reduction in its market share as technological competence in this industry is a must and customers would shift to manufactures providing latest in car technology.
- The company does not want to issue new equity shares and its retained earning are not enough for such a large investment. Thus, the only option is raising debt.
- The company wants to limit its additional debt to a level that it can service without taking undue risks. With the looming recession and uncertain market conditions, the company perceives that additional fixed obligations could become a cause of financial distress, and thus, wants to determine its additional debt capacity to meet the investment requirements.
Mr. Shortsighted, the company’s Finance Manager, is given the task of determining the additional debt that the firm can raise. He thinks that the firm can raise Rs. 100 crore worth debt and service it even in years of recession. The company can raise debt at 15 per cent from a financial institution. While working out the debt capacity. Mr. Shortsighted takes the following assumptions for the recession years.
- A maximum of 10 percent reduction in sales volume will take place.
- A maximum of 6 percent reduction in sales price of cars will take place.
Mr. Shorsighted prepares a projected income statement which is representative of the recession years. While doing so, he determines what he thinks are the “irreducible minimum” expenditures under recessionary conditions. For him, risk of insolvency is the main concern while designing the capital structure. To support his view, he presents the income statement as shown in Exhibit 3.
Exhibit 3 projected Profit and Loss account
(Amount in Rs. Crore)
Sales revenue (72,000 units x Rs. 2,35,000) 1,692.0
Operating expenditure
Variable cost :
Raw material and manufacturing expenses 1,170.0
Variable overheads 90.0
Total 1,260.0
Fixed cost :
R & D —
Marketing and advertising 15.0
Depreciation 187.5
Personnel 70.0
Total 272.5
Total operating expenditure 1,532.5
EBIT 159.5
Financial expenses :
Interest on existing Debentures 7.0
Interest on existing institutional borrowings 10.0
Interest on commercial loan 30.0
Interest on additional debt 15.0 62.0
EBT 97.5
Tax (@ 35%) 34.1
EAT 63.4
Dividends —
Debt redemption (sinking fund obligation) 50.0*
Contribution to reserves and surplus 13.4
* Rs. 40 crore (existing debt) + Rs. 10 crore (additional debt)
Assumptions of Mr. Shorsighted
- R & D expenditure can be done away with till the economy picks up.
- Marketing and advertising expenditure can be reduced by 40 per cent.
- Keeping in mind the investor confidence that the company enjoys, he feels that the company can forgo paying dividends in the recession period.
He goes with his worked out statement to the Director Finance, Mr. Arthashatra, and advocates raising Rs. 100 crore of debt to finance the intended capital investment. Mr. Arthashatra does not feel comfortable with the statements and calls for the company’s financial analyst, Mr. Longsighted.
Mr. Longsighted carefully analyses Mr. Shortsighted’s assumptions and points out that insolvency should not be the sole criterion while determining the debt capacity of the firm. He points out the following :
- Apart from debt servicing, there are certain expenditures like those on R & D and marketing that need to be continued to ensure the long-term health of the firm.
- Certain management policies like those relating to dividend payout, send out important signals to the investors. The Zip Zap Zoom’s management has been paying regular dividends and discontinuing this practice (even though just for the recession phase) could raise serious doubts in the investor’s mind about the health of the firm. The firm should pay at least 10 per cent dividend in the recession years.
- Mr. Shortsighted has used the accounting profits to determine the amount available each year for servicing the debt obligations. This does not give the true picture. Net cash inflows should be used to determine the amount available for servicing the debt.
- Net Cash inflows are determined by an interplay of many variables and such a simplistic view should not be taken while determining the cash flows in recession. It is not possible to accurately predict the fall in any of the factors such as sales volume, sales price, marketing expenditure and so on. Probability distribution of variation of each of the factors that affect net cash inflow should be analyzed. From this analysis, the probability distribution of variation in net cash inflow should be analysed (the net cash inflows follow a normal probability distribution). This will give a true picture of how the company’s cash flows will behave in recession conditions.
The management recognizes that the alternative suggested by Mr. Longsighted rests on data, which are complex and require expenditure of time and effort to obtain and interpret. Considering the importance of capital structure design, the Finance Director asks Mr. Longsighted to carry out his analysis. Information on the behaviour of cash flows during the recession periods is taken into account.
The methodology undertaken is as follows :
- Important factors that affect cash flows (especially contraction of cash flows), like sales volume, sales price, raw materials expenditure, and so on, are identified and the analysis is carried out in terms of cash receipts and cash expenditures.
- Each factor’s behaviour (variation behaviour) in adverse conditions in the past is studied and future expectations are combined with past data, to describe limits (maximum favourable), most probable and maximum adverse) for all the factors.
- Once this information is generated for all the factors affecting the cash flows, Mr. Longsighted comes up with a range of estimates of the cash flow in future recession periods based on all possible combinations of the several factors. He also estimates the probability of occurrence of each estimate of cash flow.
Assuming a normal distribution of the expected behaviour, the mean expected
value of net cash inflow in adverse conditions came out to be Rs. 220.27 crore with standard deviation of Rs. 110 crore.
Keeping in mind the looming recession and the uncertainty of the recession behaviour, Mr. Arthashastra feels that the firm should factor a risk of cash inadequacy of around 5 per cent even in the most adverse industry conditions. Thus, the firm should take up only that amount of additional debt that it can service 95 per cent of the times, while maintaining cash adequacy.
To maintain an annual dividend of 10 per cent, an additional Rs. 35 crore has to be kept aside. Hence, the expected available net cash inflow is Rs. 185.27 crore (i.e. Rs. 220.27 – Rs. 35 crore)
Question:
Analyse the debt capacity of the company.
CASE – 2 GREAVES LIMITED
Started as trading firm in 1922, Greaves Limited has diversified into manufacturing and marketing of high technology engineering products and systems. The company’s mission is “manufacture and market a wide range of high quality products, services and systems of world class technology to the total satisfaction of customers in domestic and overseas market.”
Over the years Greaves has brought to India state of the art technologies in various engineering fields by setting up manufacturing units and subsidiary and associate companies. The sales of Greaves Limited has increased from Rs 214 crore in 1990 to Rs 801 crore in 1997. The sales of Greaves Limited has increased from Rs 214 crore in 1990 to Rs 801 crore in 1997. Profits before interest and tax (PBIT) of the company increased from Rs 15 crore to Rs 83 crore in 1997. The market price of the company’s share has shown ups and downs during 1990 to 1997. How has the company performed? The following question need answer to fully understand the performance of the company:
Exhibit 1
| GREAVES LTD.
Profit and Loss Account ending on 31 March (Rupees in crore) |
||||||||
| 1990 | 1991 | 1992 | 1993 | 1994 | 1995 | 1996 | 1997 | |
| Sales
Raw Material and Stores Wages and Salaries Power and fuel Other Mfg. Expenses Other Expenses Depreciation Marketing and Distribution Change in stock |
214.38
170.67 13.54 0.52 0.61 11.85 1.85 4.86 1.18 |
253.10
202.84 15.60 0.70 0.49 15.48 1.72 5.67 3.10 |
287.81
230.81 18.03 1.11 0.88 16.35 1.52 5.14 4.93 |
311.14
213.79 37.04 3.80 2.37 25.54 4.62 5.17 0.48 |
354.25
245.63 37.96 4.43 2.36 31.60 5.99 9.67 – 1.13 |
521.56
379.83 48.24 6.66 3.57 41.40 8.53 10.81 5.63 |
728.15
543.56 60.48 7.70 4.84 45.74 9.30 12.44 11.86 |
801.11
564.35 69.66 9.23 5.49 48.64 11.53 16.98 – 5.87 |
| Total Op Expenses | 202.72 | 239.40 | 268.91 | 291.85 | 338.77 | 493.41 | 672.20 | 731.75 |
|
Operating Profit Other Income Non-recurring Income |
11.61 2.14 1.30 |
13.70 3.69 2.28 |
18.90 4.97 0.10 |
19.29 4.24 10.98 |
15.48 7.72 16.44 |
28.15 14.35 0.46 |
55.95 11.35 0.52 |
69.36 13.08 1.75 |
| PBIT | 15.10 | 19.67 | 23.97 | 34.51 | 39.64 | 42.98 | 65.67 | 82.64 |
| Interest | 5.56 | 6.77 | 11.92 | 19.62 | 17.17 | 21.48 | 28.25 | 27.54 |
| PBT | 9.54 | 12.90 | 12.05 | 14.89 | 22.47 | 21.50 | 37.42 | 55.10 |
| Tax
PAT Dividend Retained Earnings |
3.00
6.54 1.80 4.74 |
3.60
9.30 2.00 7.30 |
4.90
7.15 2.30 4.85 |
0.00
14.89 4.06 10.83 |
4.00
18.47 7.29 11.18 |
7.00
14.50 8.58 5.92 |
8.60
28.82 12.85 15.97 |
15.80
39.30 14.18 25.12 |
Exhibit 2
| GREAVES LTD.
Balance Sheet (Rupees in crore) |
||||||||
| 1990 | 1991 | 1992 | 1993 | 1994 | 1995 | 1996 | 1997 | |
| ASSETS
Land and Building Plant and Machinery Other Fixed Assets Capital WIP Gross Fixed Assets Less: Accu. Depreciation Net Tangible Fixed Assets Intangible Fixed Assets |
3.88 11.98 3.64 0.09 19.59 12.91 6.68 0.21 |
4.22 12.68 4.14 0.26 21.30 14.56 6.74 0.19 |
4.96 12.98 4.38 10.25 23.57 15.79 7.78 0.05 |
21.70 33.49 5.18 11.27 71.64 19.84 51.80 4.40 |
30.82 50.78 6.95 34.84 123.39 25.74 97.65 22.03 |
39.71 75.34 8.53 14.37 137.95 33.90 104.05 22.45 |
42.34 92.49 8.87 13.92 157.62 42.56 115.06 20.04 |
43.07 104.45 10.35 14.36 172.23 53.87 118.86 21.11 |
| Net Fixed Assets | 6.89 | 6.93 | 7.83 | 56.20 | 119.68 | 126.50 | 135.10 | 139.97 |
|
Raw Materials Finished Goods Inventory Accounts Receivable Other Receivable Investments Cash and Bank Balance Current Assets Total Assets LIABILITIES AND CAPITAL Equity Capital Preference Capital Reserves and Surplus |
5.26 29.37 34.63 38.16 32.62 3.55 8.36 117.32 124.21
9.86 0.20 27.60 |
6.91 33.72 40.63 53.24 40.47 14.95 8.91 158.20 165.13
9.86 0.20 32.57 |
7.26 38.65 45.91 67.97 49.19 15.15 12.71 190.93 198.76
9.86 0.20 37.42 |
21.05 53.39 74.44 93.30 24.54 27.58 13.29 233.15 289.35
18.84 0.20 100.35 |
28.13 52.26 80.39 122.20 59.12 73.50 18.38 353.59 473.27
29.37 0.20 171.03 |
44.03 58.09 102.12 133.45 64.32 75.01 30.08 404.98 531.48
29.44 0.20 176.88 |
53.62 69.97 123.59 141.82 76.57 75.07 33.46 450.51 585.61
44.20 0.20 175.41 |
50.94 64.09 115.03 179.92 107.31 76.45 48.18 526.89 666.86
44.20 0.20 198.79 |
| Net Worth | 37.66 | 42.63 | 47.48 | 119.39 | 200.60 | 206.52 | 219.81 | 243.19 |
| Bank Borrowings
Institutional Borrowings Debentures Fixed Deposits Commercial Paper Other Borrowings Current Portion of LT Debt |
14.81
4.13 4.77 12.31 0.00 2.33 0.00 |
19.45
3.43 16.57 14.45 0.00 3.22 0.00 |
26.51
9.17 19.99 15.03 0.00 3.10 0.08 |
24.82
38.09 4.56 14.08 0.00 3.18 0.12 |
55.12
38.76 4.37 15.57 15.00 17.08 15.08 |
64.97
69.69 4.37 17.75 0.00 1.97 0.02 |
70.08
89.26 2.92 20.81 0.00 2.36 1.49 |
118.28
63.60 1.49 19.29 0.00 2.57 1.57 |
| Borrowings | 38.35 | 57.12 | 73.72 | 84.61 | 130.82 | 158.73 | 183.94 | 203.66 |
| Sundry Creditors
Other Liabilities Provision for tax, etc. Proposed Dividends Current Portion of LT Dept |
37.52
5.70 3.18 1.80 0.00 |
49.40
10.16 3.82 2.00 0.00 |
59.34
10.70 5.14 2.30 0.08 |
77.27
3.59 0.31 4.06 0.12 |
113.66
1.42 4.40 7.29 15.08 |
148.13
1.99 7.70 8.58 0.02 |
153.63
1.70 12.19 12.85 1.49 |
179.79
3.04 21.43 14.18 1.57 |
| Current Liabilities | 48.20 | 65.38 | 77.56 | 85.35 | 141.85 | 166.42 | 181.86 | 220.01 |
| TOTAL LIABILITIES
Additional information: Share premium reserve Revaluation reserve Bonus equity capital |
124.21
8.51 |
165.13
8.51 |
198.76
8.51 |
289.35
47.69 8.91 8.51 |
473.27
107.40 8.70 8.51 |
531.67
107.91 8.50 8.51 |
585.61
93.35 8.31 23.25 |
666.86
93.35 8.15 23.25 |
Exhibit 3
| GREAVES LTD.
Share Price Data |
||||||||
| 1990 | 1991 | 1992 | 1993 | 1994 | 1995 | 1996 | 1997 | |
| Closing share price (Rs)
Yearly high share price (Rs) Yearly low share price (Rs) Market capitalization (Rs crore EPS (Rs) Book value (Rs) |
27.19
29.25 26.78 65.06 4.79 35.64 |
34.74
45.28 21.61 67.77 6.82 37.22 |
121.27
121.27 34.36 236.56 9.73 42.54 |
66.67
126.33 48.34 274.84 1.93 57.75 |
78.34
90.00 42.67 346.35 2.66 40.61 |
71.67
100.01 68.34 316.87 7.16 64.98 |
47.5
90.00 45.00 210.02 5.03 45.35 |
48.25
85.00 43.75 213.34 9.01 50.73 |
Questions
- How profitable are its operations? What are the trends in it? How has growth affected the profitability of the company?
- What factors have contributed to the operating performance of Greaves Limited? What is the role of profitability margin, asset utilisation, and non-operating income?
- How has Greaves performed in terms of return on equity? What is the contribution of return on investment, the way of the business has been financed over the period?
CASE – 3 CHOOSING BETWEEN PROJECTS IN ABC COMPANY
ABC Company, has three projects to choose from. The Finance Manager, the operations manager are discussing and they are not able to come to a proper decision. Then they are meeting a consultant to get proper advice. As a consultant, what advice you will give?
The cash flows are as follows. All amounts are in lakhs of Rupees.
Project 1:
Duration 5 Years
Beginning cash outflow = Rs. 100
Cash inflows (at the end of the year)
Yr. 1 – Rs 30; Yr. 2 – Rs 30; Yr. 3 – Rs 30; Yr.4 – 10; Yr.5 – 10
Project 2:
Duration 5 Years
Beginning Cash outflow Rs. 3763
Cash inflows (at the end of the year)
Yr. 1 – 200; Yr. 2 – 600; Yr. 3 – 1000; Yr. 4 – 1000; Yr. 5 – 2000.
Project 3:
Duration 15 Years
Beginning Cash Outflow – Rs. 100
Cash Inflows (at the end of the year)
Yrs. 1 to 10 – Rs. 20 (for 10 continuous years)
Yrs. 11 to 15 – Rs. 10 (For the next 5 years)
Question:
If the cost of capital is 8%, which of the 3 projects should the ABC Company accept?
CASE – 4 STAR ENGINEERING COMPANY
Star Engineering Company (SEC) produces electrical accessories like meters, transformers, switchgears, and automobile accessories like taximeters and speedometers.
SEC buys the electrical components, but manufactures all mechanical parts within its factory which is divided into four production departments Machining, Fabrication, Assembly, and Painting—and three service departments—Stores, Maintenance, and Works Office.
Though the company prepared annual budgets and monthly financial statements, it had no formal cost accounting system. Prices were fixed on the basis of what the market can bear. Inventory of finished stocks was valued at 90 per cent of the market price assuming a profit margin of 10 per cent.
In March, the company received a trial order from a government department for a sample transformer on a cost-plus-fixed-fee basis. They took up the job (numbered by the company as Job No 879) in early April and completed all manufacturing operations before the end of the month.
Since Job No 879 was very different from the type of transformers they had manufactured in the past, the company did not have a comparable market price for the product. The purchasing officer of the government department asked SEC to submit a detailed cost sheet for the job giving as much details as possible regarding material, labour and overhead costs.
SEC, as part of its routine financial accounting system, had collected the actual expenses for the month of April, by 5th of May. Some of the relevant data are given in Exhibit A.
The company tried to assign directly, as many expenses as possible to the production departments. However, It was not possible in all cases. In many cases, an overhead cost, which was common to all departments had to be allocated to the various departments using some rational basis. Some of the possible bases were collected by SEC’s accountant. These are presented in Exhibit B.
He also designed a format to allocate the overhead to all the production and service departments. It was realized that the expenses of the service departments on some rational basis. The accountant thought of distributing the service departments’ costs on the following basis:
- Works office costs on the basis of direct labour hours.
- Maintenance costs on the basis of book value of plant and machinery.
- Stores department costs on the basis of direct and indirect materials used.
The accountant who had to visit the company’s banker, passed on the papers to you for the required analysis and cost computations.
REQUIRED
Based on the data given in Exhibits A and B, you are required to:
- Complete the attached “overhead cost distribution sheet” (Exhibit C).
Note: Wherever possible, identify the overhead costs chared directly to the production and service departments. If such direct identification is not possible, distribute the costs on some “rational basis. - Calculate the overhead cost (per direct labour hour) for each of the four producing departments. This should include share of the service departments’ costs.
- Do you agree with:
a. The procedure adopted by the company for the distribution of overhead costs?
b. The choice of the base for overhead absorption, i.e. labour-hour rate?
Exhibit A
| STAR ENGINEERING COMPANY
Actual Expenses(Manufacturing Overheads) for April |
|||||||||||
| RS | RS | ||||||||||
| Indirect Labour and Supervisions:
Machining Fabrication Assembly Painting Stores Maintenance
Indirect Materials and Supplies Machining Fabrication Assembly Painting Maintenance
Others Factory Rent Depreciation of Plant and Machinery Building Rates and Taxes Welfare Expenses (At 2 per cent of direct labour wages and Indirect labour and supervision) Power (Maintenance—Rs 366; Works Office Rs 2,200, Balance to Producing Departments) Works Office Salaries and Expenses Miscellaneous Stores Department Expenses |
33,000 22,000 11,000 7,000 44,000 32,700 1,100 3,300 3,400 2,800
1,68,000 44,000 2,400 19,400
68,586
1,30,260 1,190
|
1,49,700
12,800
4,33,930 5,96,930 |
|||||||||
Exhibit B
| STAR ENGINEERING COMPANY
Projected Operation Data for the Year |
||||||
| Department | Area
(sq.m) |
Original Book of Plant & Machinery
Rs |
Direct Materials
Budget
Rs |
Horse
Power Rating |
Direct
Labour Hours |
Direct
Labour Budget
Rs |
| Machining
Fabrication Assembly Painting Stores Maintenance Works Office Total
|
13,000
11,000 8,800 6,400 4,400 2,200 2,200 48,000 |
26,40,000
13,20,000 6,60,000 2,64,000 1,32,000 1,98,000 68,000 52,80,000 |
62,40,000
21,60,000
10,80,000
94,80,000 |
20,000
10,000 1,000 2,000
33,000 |
14,40,000
5,28,000 7,20,000 3,30,000
30,18,000 |
52,80,000
25,40,000 13,20,000 6,60,000
99,00,000 |
Note
The estimates given in this exhibit are for the budgeted year January to December where as the actuals in Exhibit A are just one month—April of the budgeted year.
| Exhibit C
STAR ENGINEERING COMPANY Actual Overhead Distribution Sheet for April |
|||||||||||
| Departments
Overhead Costs |
Production Departments | Service Departments | Total Amount Actuals for April (Rs) | Basis for Distribution | |||||||
| A. Allocation of Overhead to all departments
A.1 Indirect Labour and Supervision |
1,49,700 |
||||||||||
| A.2 Indirect materials and supplies |
12,800 |
||||||||||
| A.3 Factory Rent | 1,68,000 | ||||||||||
| A.4 Depreciation of Plant and Machinery |
44,000 |
||||||||||
| A.5 Building Rates and Taxes
|
2,400
|
||||||||||
| A.6 Welfare Expenses
|
19,494 |
||||||||||
| A.7 Power | 68,586 | ||||||||||
| A.8 Works Office Salaries and Expenses |
1,30,260 |
|
|||||||||
|
A.9 Miscellaneous Stores Expenses |
1,190 |
||||||||||
| A. Total (A.1 to A.9) | 5,96,430 | ||||||||||
| B. Reallocation of Service Departments Costs to Production Departments | |||||||||||
| B.1 Distribution of Works Office Costs | |||||||||||
| B.2 Distribution of Maintenance Department’s Costs | |||||||||||
| B.3 Distribution of Stores Department’s Costs | |||||||||||
| Total Charged to Producing
C. Departments (A+B) |
5,96,430 |
||||||||||
| D. Labour Hours Actuals for April |
1,20,000 |
44,000 |
60,000 |
27,500 |
|||||||
| E. Overhead Rate/Per Hour (D) | |||||||||||
Case 5: EASTERN MACHINES COMPANY
Raj who was in charge production felt that there are many problems to be attended to. But Quality Control was the main problem, he thought, as he found there were more complaints and litigations as compared to last year. With the demand increasing, he does not want to take any chances.
So he went down to assembly line, but was greeted by an unfamiliar face. He introduced himself.
Raj: I am in charge of checking the components, which we use, when we assemble the machines for customers. For most of the components, suppliers are very reliable and we assume that there will not be any problem. When we generally test the end product, we don’t have failures.
Namdeo: I am Namdeo. I was in another dept. and has been transferred recently to this dept.
Raj: Recently we have been having problems, and there has been some complaint or other about the machines we have supplied. I am worried and would like to check the components used. I would like to avoid lot of expensive rework.
Namdeo: But it would be very expensive to test every one of them. It will take at least half an hour for each machine. I neither have the staff nor the time. It will be rather pointless as majority of them will pass the test.
Raj: There has been more demand than supply for these machines in last 2 years. We have been buying many components from many suppliers. We have been producing more with extra shifts. We are trying to capture the market and increase our market share.
Namdeo: We order for components from different places, and sometimes we do not have time to check all. There is a time lag between order and supply of components, and we cannot wait as production will stop. We use whatever comes soon as we want to complete our orders.
Raj: Oh! Obviously we need some kind of checking. Some sampling technique to check the quality of the components. We need to get a sample from each shipment from our component suppliers. But I do not know how many we should test.
Namdeo: We should ask somebody from our statistics dept. to attend to this problem.
As a Statistician, advice what kind of Sampling schemes can we consider and what factors will influence choice of scheme. What are the questions we should ask Mr. Namdeo, who works in the assembly line?