Question

Cascade’s management is considering the proposal from FHP. There are many issues involving strategy,cost, risk, and capacity. Prepare a recommendation to management. Use the following questions to guide
your analysis.

1. Assume Cascade could service the contract with existing equipment. Use Exhibit 1 to identify the relevant costs concerning the acceptance of FHP’s request to add two additional loads per week. Which costs are not relevant? Why?
2. Calculate the contribution per mile and total annual contribution associated with accepting FHP’s
   proposal. What do you recommend? (Use 52 weeks per year in your calculations.)
3. Consider the strategic implications (including risks) associated with expanding (or choosing not to expand) operations to meet the demands of FHP. Analyze this question from a conceptual point of view.
   Calculations are not necessary.
4. After a closer examination of capacity, management believes an additional rig is required to service the
   FHP account. Assume Cascades’s management chooses to invest in one additional truck and trailer that can serve the needs of FHP (at least initially). Assume the annual incremental fixed costs associated with acquiring the additional equipment is $50,000. Further, FHP would agree to pay $2.20 per mile (total
   including FSC and miscellaneous) if Cascade would sign a five-year contract. What is the annual number of miles required for Cascade to break even, assuming the company adds one truck and trailer? What is the expected annual increase in profitability from the FHP contract? (Use 52 weeks per year in
   your calculations.)
5. Cascade has business relationships with independent contractors, though Alan is reluctant to use them.
   Another possibility for expanding capacity is to outsource the miles requested by FHP. One of Cascade’s most reliable independent contractors has quoted a rate of $1.65 per mile. As with question 4, assume FHP would agree to pay $2.20 per mile if Cascade would sign a five-year contract. Further, assume Cascade would incur incremental fixed costs of $20,000 annually. These costs would include
   insurance, rental trailers, certain permits, salaries and benefits of garage maintenance, and office salariessuch as billing. How many annual miles are required for Cascade to break even if the miles areoutsourced? What is the expected annual increase in profitability from the FHP contract? What are your
   conclusions?
6.     6a Why might Cascade use an independent operator if the variable cost per mile is higher than if the company had purchased a rig and hired a driver?

6b. At what point would management be indifferent between the scenarios illustrated in questions 4 and 5? Based on your analysis, would you recommend adding capacity by purchasing an additional rig or by utilizing the services of an independent contractor? Why?

Answer 1

Question 1: Assume Cascade could service the contract with existing equipment. Use Exhibit 1 to identify the relevant costs concerning the acceptance of FHP’s request to add two additional loads per week. Which costs are not relevant? Why?

Answer: Here the assumption is that Cascade is NOT going to purchase new equipment to meet FHP's proposal. With this, there is NO additional cost for Cascade for buying new equipment. So the answer to the question - which costs are not relevant?

Additional purchase cost for equipment is not relevant here. Why - because the presumption is that Cascade uses the existing equipment to cater to FHP's proposal.