Question

[The following information applies to the questions displayed below.] Lightening Bulk Company is a moving company specializing in transporting large items worldwide. The firm has an 94% on-time delivery rate. Twenty-two percent of the items are misplaced and the remaining 2% are lost in shipping. On average, the firm incurs an additional $74 per item to track down and deliver misplaced items. Lost items cost the firm about $390 per item. Last year, the firm shipped 6,090 items with an average freight bill of $290 per item shipped. The firm's manager is considering investing in a new scheduling and tracking system costing $251,000 per year. The new system is expected to reduce misplaced items to 10% and lost items to 0.50%. Furthermore, the firm expects total sales to increase by 19% with the improved service. The average contribution margin ratio on any increased sales volume, after cost savings associated with a reduction in misplaced and lost items, is expected to be 46.5%. Required: 1a. Based on a relevant cost analysis, should the firm install the new tracking system? Yes O No

Answer 1

ANSWER

Part 1a) and 1b)

The estimated change in pretax cash flow under the proposed system is calculated as below:

Lightening Bulk Company
Cost and Benefit Analysis of the Proposed Scheduling and Tracking System
Cost of the new system (per year)		251,000
Expected benefits each year from the new system:
Contribution margin from sales increase (6,090*19%*290*46.5%)	156,035
Savings from decrease in misplaced items [6,090*(22% - 10%)*74]	89,230
Savings from decrease in lost items [6,090*(2% - .50%)*390]	47,264	292,529
Change in pre-tax cash flow per year		$41,529

YES, the firm install the new tracking system as it results in a POSITIVE change in pre-tax cash flow per year.

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Part 3)

The maximum amount for process improvements is arrived as below:

Cost of misplaced items (6,090*22%*89%*74)	88,239
Cost of lost items (6,090*2%*89%*390)	42,277
Total cost of lost and misplaced items (A)	130,516
Targeted reduction in total cost (B)	99%
Maximum amount for process improvements (A*B)	$129,211

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