Question

Pack-and-Go, a new competitor to FedEx and UPS, does intra-city package deliveries in seven major metropolitan areas. The performance of Pack-and-Go is measured by management as: (1) delivery time (relative to budgeted delivery time), (2) on-time delivery rates (defined as agreed-upon delivery date/time plus or minus a specified cushion), and (3) percentage of lost or damaged deliveries. In response to competitive pressures, Pack-and-Go is evaluating an investment in new technology that would improve customer service and delivery quality, particularly in terms of items (2) and (3) above. The cost of the new technology, for each of the seven metropolitan areas serviced by Pack-and-Go, is expected to be $80,000. You have gathered the following information regarding delivery performance under both existing operations and after implementing the new technology: Decision Alternative Item Current System After Implementing New Technology On-time delivery rate 80 % 95 % Variable cost per package lost or damaged $30 $30 Allocated fixed cost per package lost or damaged $10 $10 Annual no. of packages lost or damaged 300 100 Based on a recent marketing study commissioned by Pack-and-Go, the company estimates that each percentage point increase in the on-time performance rate would lead to an annual revenue increase of $10,000. The average contribution margin ratio for packages delivered by Pack-and-Go is estimated as 40%.

Required:

1.	From a financial perspective, calculate the net financial benefit per year.

       

2.

Based on the data collected by Pack-and-Go, the company is fairly confident about the reduction in costs associated with lost or damaged packages. However, because of uncertainties in terms of pricing in the markets in which Pack-and-Go operates, it is less sure about the predicted increase in revenues associated with the implementation of the new technology. What is the breakeven increase in annual revenue that would justify the investment in the new technology?

Required:

1.	From a financial perspective, calculate the net financial benefit per year.

       

2.

Based on the data collected by Pack-and-Go, the company is fairly confident about the reduction in costs associated with lost or damaged packages. However, because of uncertainties in terms of pricing in the markets in which Pack-and-Go operates, it is less sure about the predicted increase in revenues associated with the implementation of the new technology. What is the breakeven increase in annual revenue that would justify the investment in the new technology?

       

Answer 1

1) Calculation of Net Financial Benefit per year:

Here Company is Considering investing on New technology that will increase (2) and (3) performance above

(2) -On time delivery rate- Clearly there is increase of 15% points (95-80) in Ontime delivery performance. Since each percentage point increase would result in $10000 annual revenue increase and average contribution margin ratio is 40%. This means Contribution margin ratio = Contribution margin / sales. So Contribution margin= 40%* 10000= $4000. So 15 % points increase results in 15* 4000=$60000

(3)-Reduction in Last or damaged goods- Clearly there is decrease of 200 packages P.A after implementation of New technology.Since Fixed cost will not change with change in sales and it will not have effect on any Decision making because whether or not this new technology is installed or not Fixed costs will not change. So the variable cost per package saved is $30. So the total varible costs saved=30*200=$6000.

Net Financial benefit=60000+6000=$66000

2) Since each percentage point increase in the Ontime performance would result in $10000 annual revenue increase. Also $40% is contribution margin ratio. So Each percentage point increase in Ontime performance would result in $4000 increase in contribution margin. To break even the investment in New technology the Company has to increase annual revenue by ($80000-$6000)/(0.4*15)=12334 (Since $80000 is investment in new technology and $6000 is saving in Lost and damaged goods calculated above).