Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 46

Relevant Costs and Quality Improvement Lightening Bulk Company is a moving company specializing in transporting large items worldwide. The firm has an 85 percent on-time delivery rate. Twelve percent of the items are misplaced and the remaining 3 percent are lost in shipping. On average, the firm incurs an additional $60 per item to track down and deliver misplaced items. Lost items cost the firm about $300 per item. Last year the firm shipped 5,000 items with an average freight bill of $200 per item shipped.

The firm’s manager is considering investing in a new scheduling and tracking system costing $150,000 per year. The new system is expected to reduce misplaced items to 1 percent and lost items to 0.5 percent. Furthermore, the firm expects total sales to increase by 10 percent with the improved service. The average contribution margin on any increased sales volume is expected to be 40%.

Required

1. Based on a relevant-cost analysis, should the firm install the new tracking system? Show calculations.

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2. What other factors does the firm’s manager need to consider in making the decision?

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3. Upon further investigation, the manager discovered that 80 percent of the misplaced or lost items either originated in or were delivered to the same country. What is the maximum amount the firm should spend to reduce the problems in that country by 90 percent?

Step 1 of 3

Relevant Costs and Quality Improvement (20–30 minutes)

1.

Lightening Bulk Company
Cost and Benefit Analysis of the Proposed
Scheduling and Tracking System
Cost of the new system (per year)		$ 150,000
Expected benefits each year from the new system:
Contribution margin from sales increase:
(5,000 x 10%) x $200 x 40% =	$ 40,000
Savings foregone from decrease in misplaced
items—existing sales: 5,000 x (12% – 1.0%) x $60 =	33,000
Savings foregone from decrease in lost items—existing
sales: 5,000 x (3.0% – 0.50%) x $300 =	37,500
Pre-tax cash flow per year		($39,500)

The new scheduling and tracking system will most likely decrease the firm‘s pre-tax cash flow per year. Thus, from a purely financial point of view the company cannot justify the purchase of the new system.