2 - CVP analysis and Decision Making[30 Marks]

Mr. Faisal Din is the manager of Saadat Farm and Seed Company, a wholesaler of fertilizer, seed, and other agricultural supplies. The company has been successful in last few years primarily because of great customer serviceflexible credit terms, customized orders (quantities, types of seed mix, etc.), and timely delivery, among others. Hafsa Agricultural Products, Saadat's parent company, has informed Mr. Faisal Din that his target net income for the coming year will be Rs.120m.

After the determination of the budget, Faisal Din received notice from Saadat's main shipping agent that it was about to increase its rates by 10%. This carrier handles 90% of Saadat's total shipping volume. Paying the increased rate may result in failure to meet the budgeted income level, and Mr. Faisal Din is understandably reluctant to allow that to happen. Shipping costs can be assumed to strictly variable. He is considering two alternatives. First, it is possible to use alternate 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 Rs.70m.

Assume that prior to the recent rate increase, the shipping costs of the main carrier and the other carriers were the same, and that costs of the other carriers are not expected to change.

As another alternative, Saadat can purchase its own trucks thereby reducing its shipping costs to 85% of the original rate. The new trucks would have an expected useful life of 10 years, no salvage value and would be depreciated on a straight line basis. Related fixed costs (maintenance of trucks etc.) excluding depreciation would be Rs.2m. Assume that if Saadat purchases the trucks, Saadat will replace the main shipper and the other shippers.

Following are data from the prior year:

Sales ......................................................

Rs.1540m

Variable costs (excluding shipping).....

1,095m

Shipping costs ........................................

139m

Fixed costs .............................................

150m

Required:

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

[10 Marks]

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

[10 Marks]

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

[10 Marks]