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 annual 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 Alernative
After Implementing
Item Current System 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 number 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, should pack-and-Go invest in the new technology?
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 break-even increase in annual revenue that would justify the investment in the new technology?

Answer 1

Pack-and-Go

1. From a financial perspective, Pack-and-Go should invest in the new technology. It will enjoy a contribution margin of 97.5%.

2. The break-even increase in annual revenue that would justify the investment in the new technology is:

Fixed cost = Contribution

$80,000 = Contribution - $8,000

= $72,000 ($80,000 - $8,000

Step-by-step explanation:

a) Data and Calculations:

Expected cost of new technology investment = $80,000

Delivery performance:

Decision Alternative

After Implementing

Item Current System 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 number of packages

lost or damaged 300 100

Variable cost for lost or

damaged packages $9,000 (300*$30) $3,000 (100*$30)

Fixed cost for lost or

damaged packages 3,000 (300*$10) $1,000 (100*$10)

Total cost for lost or

damaged packages $12,000 $4,000

Increase in the on-time performance rate = 95% - 80% = 15%

Increase in annual Revenue = $10,000 * 15 = $150,000

Savings from lost or damaged packages = 8,000 ($12,000 - $4,000)

Total savings from new technology = $158,000

Annual cost of new technology = (80,000)

Net savings from new technology = $78,000

Contribution margin based on net savings = $78,000/$80,000 * 100 = 97.5%

Average contribution margin = 40%