Question

PLEASE ANSWER #5! thanks!

Roadrunner Trucking Company is a nationwide truckload carrier. They operate in a highly-competitive market on a very thin margin. Below are the projected figures for 2016: Revenue per mile $5.00 Variable cost per mile $ 4.50 Projected fixed costs $5,000,000 Desired after tax profit $500,000 Tax rate 25%

1. Compute the contribution rate and computation rate margin.

2. Calculate the breakeven in miles and sales dollars based on the information from Question 1.

3. Management is reviewing a proposal from their liability insurance company. The proposal suggests the company change their premium from a fixed to a variable rate. If accepted, this would increase the variable costs by 25 cents per mile and drop the fixed costs by 2%. Should they make the change? Show calculations to support or answer.

4. Shareholders are pressuring management to increase after-tax profit and thus increase the amount of dividends that can be paid. Management thinks they can increase revenue per mile by 5% and with an aggressive cost-cutting program, which will reduce fixed costs by 10%. With this program they project after-tax profits would increase by 15%.

5. Compare the three alternatives. Which is best? Explain your answer.

Answer 1

Solution

Roadrunner Trucking Company

1. Computation of contribution rate and rate margin:

Contribution margin = sales – variable cost

Revenue = $5 per mile

Variable cost = $4.50 per mile

Contribution margin = 5 – 4.50 = $0.50 per mile

Contribution margin rate = contribution margin/revenue

            = $0.50/$5 = 10%

1. BEP in miles and sales dollars –

BEP in miles = fixed cost/contribution margin per mile

Fixed cost = $5,000,000

CM = $0.50

BEP in miles = $5,000,000/$0.50 = 10,000,000 miles

BEP in sales dollars = fixed cost/CM rate

= $5,000,000/10% = $50,000,000

1. Analysis of three alternatives –

Alternative 1:

Increase variable cost by $0.25

Total variable cost would be = $4.50 + $0.25 = $4.75 per mile        

Drop fixed cost by 2%, which makes fixed cost = 5,000,000 – 2% x 5,000,000 = $4,900,000

With revised data,

Contribution margin = $5 - $4.75 = $0.25 per mile

Contribution margin rate = 0.25/5 = 5%

BEP in miles = $4,900,000/$0.25 = 19,600,000 miles

BEP in dollars = 4,900,000/5% = $98,000,000

Desired after tax profits = $500,000

Tax rate = 25%

Profits before tax = 500,000/75% = $666,667

Add: fixed cost = $4,900,000

Contribution margin = $5,566,667

Miles = $5,566,667/$0.25 = 22,266,667

Revenue = $5 x 22,266,667 = $111,333,333

Alternative 2:

Increase revenue per mile by 5%, hence revenue = $5 + 5% x 5 = $5.25

Reduce fixed cost by 10%, fixed cost = $5,000,000 – 10% x 5,000,000 = $4,500,000

Contribution margin = 5.25 - $4.50 = $0.75

Contribution margin rate = 0.75/5.25 = 14.29%

BEP in miles = 4,500,000/0.75 = 6,000,000 miles

BEP in sales dollars = 4,500,000/14.29% = $31,500,000

Target revenue after tax increases by 15%

= 500,000 + 15% of 500,000 = $575,000

Tax rate = 25%

Before tax income = 575,000/75% = $766,667

Add: fixed cost = $4,500,000

Contribution margin = $5,266,667

Miles = 5,266,667/$0.75 = 7,022,222 miles

Revenue = $5.25 x 7,022,222 = $36,866,667

Comparison:

	Alternative 1 (Existing Plan)	Alternative 2	Alternative 3
Sales Revenue	$56,666,670	$111,333,333	$36,866,667
miles	11,333,333	22,266,667	7,022,222
Contribution margin	$0.50	$0.25	$0.75
Contribution margin rate	10%	5%	14.29%
Total Contribution margin	$5,666,667	$5,566,667	$5,266,667
Fixed Cost	$5,000,000	$4,900,000	$4,500,000
Net Income before tax	$666,667	$666,667	$766,667
Tax at 25%	$166,667	$166,667	$191,667
After Tax income	$500,000	$500,000	$575,000
BEP in miles	10,000,000	19,600,000	6,000,000
BEP in sales dollars	$50,000,000	$98,000,000	$31,500,000

Comparison of the above three alternatives, indicate that BEP in miles is less for alternative 3, indicating that the company would break-even at 6,000,000. Also, the contribution margin rate and before tax income are higher for this alternative. So, alternative is the optimal decision.

As regards alternative 2, the BEP in miles is much higher and the company would have to wait long to break-even.

The best alternative is Alternative 3, increase revenue by 5% and reduce fixed cost by 10%.