Question

Mr. Carter is the manager of Simmons Farm and Seed Company, a wholesaler of fertilizer, seed, and other farm supplies. The company has been successful in recent years primarily because of great customer service— flexible credit terms, customized orders (quantities, seed mix, etc.), and on-time delivery, among others. Global Agricultural Products, Inc., Simmons' parent corporation, has informed Mr. Carter that his budgeted net income for the coming year will be $120,000. The budget was based on data for the prior year and Mr. Carter's belief that there would be no significant changes in revenues and expenses for the coming period. After the determination of the budget, Carter received notice from Simmons' principal shipping agent that it was about to increase its rates by 10%. This carrier handles 90% of Simmons' total shipping volume. Paying the increased rate will result in failure to meet the budgeted income level, and Mr. Carter is understandably reluctant to allow that to happen. He is considering two alternatives. First, it is possible to use another carrier whose rates are 5% less than the old carrier's original rate. The old carrier, however, is a subsidiary of a major customer; shifting to a new carrier will almost certainly result in loss of that customer and sales amounting to $70,000. Assume that prior to the recent rate increase, the shipping costs of the principal carrier and the other carriers were the same, and that costs of the other carriers are not expected to change. As a second alternative, Simmons can purchase its own trucks thereby reducing its shipping costs to 85% of the original rate. The new trucks would have an expected life of 10 years, no salvage value and would be depreciated on a straight line basis. Related fixed costs excluding depreciation would be $2,000. Assume that if Simmons purchases the trucks, Simmons will replace the principal shipper and the other shippers.

Following are data from the prior year:

Sales ............................................................ $1,500,000

Variable costs (excluding shipping) ........... 1,095,000

Shipping costs ............................................. 135,000

Fixed costs .................................................. 150,000

REQUIRED:

1. Using cost-volume-profit (CVP) analysis and the data provided, determine the maximum amount that Mr. Carter can pay for the trucks and still expect to attain budgeted net income.

2. At what price for the truck would Mr. Carter be indifferent between purchasing the new trucks and using a new carrier?

3. Mr. Carter has decided to use a new carrier, but now is worried its apparent lack of reliability may adversely affect sales volume. Determine the dollar amount of sales that Simmons can lose because of lack of reliability before any benefit from switching carriers is lost completely.

4. Describe what you think is the competitive strategy of Simmons Farm and Seed Company. What should be the strategy? How would the use of a new carrier affect the strategy?

5. Can Mr. Carter use value chain analysis to improve the profits of Simmons Farm and Seed Company? If so, explain how briefly.

Answer 1