Problem for Self-Study

The Sloan Moving Corporation transports household goods from one city to another within the continental United States. Managers measure quality of service in terms of (1) time required to transport goods, (2) on-time delivery (within 2 days of agreed-upon delivery date), and (3) number of lost or damaged items. Sloan is considering investing in a new scheduling-and-tracking system costing $160,000 per year, which should help it improve performance for items (2) and (3). The following information describes Sloan’s current performance and the expected performance if the new system is implemented:

A table shows current performance and expected performance under new system for Sloan Moving Corporation

The table depicts on-time delivery performance, variable cost per carton lost or damaged, and number of cartons lost or damaged per year in terms of current performance and expected future performance if a new system is implemented. The details of the table are as follows:

1. On-time delivery performance

    • Current performance: 85 percent

    • Expected future performance: 95 percent

2. Variable cost per carton lost or damaged

    • Current performance: 60 dollars

    • Expected future performance: 60 dollars

3. Number of cartons lost or damaged per year

    • Current performance: 3,000 cartons

    • Expected future performance: 1,000 cartons

Sloan expects each percentage point increase in on-time performance to increase revenue by $20,000 per year. Sloan’s contribution margin percentage is 45%.

  1. Should Sloan acquire the new system? Show your calculations.
  2. Sloan is very confident about the cost savings from fewer lost or damaged cartons as a result of introducing the new system but unsure about the increase in revenues. Calculate the minimum amount of increase in revenues needed to make it worthwhile for Sloan to invest in the new system.

Solution

  1. 1. Additional costs of the new scheduling-and-tracking system are $160,000 per year. Additional annual benefits of the new scheduling-and-tracking system are as follows:
A table shows additional annual benefits of the new scheduling-and-tracking system for Sloan Moving Corporation

The table depicts additional annual benefits of the new scheduling-and-tracking system for Sloan Moving Corporation. The details of the table are as follows:

1. Additional annual revenues from a 10 percent improvement in on-time performance, from 85 percent to 95 percent, 20,000 dollars per 1 percent times 10 percentage points: 200,000 dollars

2. 45 percent contribution margin from additional annual revenues, 0.45 times 200,000 dollars: 90,000 dollars

3. Decrease in variable costs per year from fewer cartons lost or damaged, 60 per carton times the quanitity 3,000 minus 1,000 cartons: 120,000 dollars

4. Total additional benefits: 210,000 dollars

  1. Because the benefits of $210,000 exceed the costs of $160,000, Sloan should invest in the new system.
  2. 2. As long as Sloan earns a contribution margin of $40,000 (to cover incremental costs of $160,000 minus relevant variable-cost savings of $120,000) from additional annual revenues, investing in the new system is beneficial. This contribution margin corresponds to additional revenues of $40,000÷0.45=$88,889.