Required: Over-land'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 Over-land 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 Over-land'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 male (total including FSC and miscellaneous) if Over-land would sign a five-year contract. What is the annual number of miles required for Over-land 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. Over-land has business relationships with independent contractors, though Alan 15 reluctant to use them Another possibility for expanding capacity is to outsource the miles requested by FHP. One of Over- land's most reliable independent contractors has quoted a rate of $165 per mile. As with question 4, assume FHP would agree to pay $2.20 per mile if Over-land would sign a five-year contract. Further, assume Over-land 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 salaries such as billing. How many annual miles are required for Over-land to break even if the miles are outsourced? What is the expected annual increase in profitability from the FHP contract? What are your conclusions? 6 a. Why might Over-land use an independent operator if the variable cost per mile is higher than if the company had purchased a rig and hired a driver? b. 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? Exhibit 1 Income from Operations (All financial information in the case has been scaled and disguised for educational purposes.) Over-land Trucking and Freight Income from Operations For the year ending December 31, 2013 E 12/31/2013 $20.975.280 4.950.160 Revenue Line Haul Fuel Surcharge Miscellaneous Total Revenue 450.120 5.375,570 Variable Expenses 675,120 Oil Lubricants Tolls Parts and Small Tools Hourly Wages Drivers Trailer Poot Expense Total Vanable Fixed Expenses Insurance Generaliability Physical Damage K o ht to page 1 Page view A Fixed Expenses Insurance General Liability Physical Damage Workers Compensation Health Insurance Security Depreciation Salaries, Benefits (Garagel Salaries, Benefits (Office) Bad Debt Expense 112,620 225.010 226,000 224,500 111,750 2.137.500 675.000 1.012,520 113.500 Permits 111.520 Rental Equipment Payroll Taxes Accounting Fees, Supplies, Computer Maintenance Miscellaneous Total Variable 1.013.000 562.500 112.350 337.510 6.975,280 Income from Operations $3 621 810 - + Fit to page Page View l A Red Exhibit 2 Over-land Balance Sheet Over-land Trucking and Freight Balance Sheet For the year ending December 31, 2013 Assets Current Assets Cash Accounts Receivable $200,000 300,000 $500,000 Total Property Plant and Equipment Land Buildings Accumulated Depreciation Buildings Tractors, Trailers, and Equipment Accumulated Depreciation 1.000.000 1000000 1.250.000 18.650.000 $16.650.000 Total $17,150.000 Total Assets tid Eni Liabilities and Equity Current Liabilities Accounts Payable Taxes Payable Current Portion of Long-Term Debt Total Current Liabilities 150,000 65,000 35.000 $250.000 Long-Term Liabilities Notes Payable 1865.000 SHRI Total Long-Term liabilities 1:5000 Total liabilities 36VOCE 148000 Required: Over-land'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 Over-land 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 Over-land'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 male (total including FSC and miscellaneous) if Over-land would sign a five-year contract. What is the annual number of miles required for Over-land 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. Over-land has business relationships with independent contractors, though Alan 15 reluctant to use them Another possibility for expanding capacity is to outsource the miles requested by FHP. One of Over- land's most reliable independent contractors has quoted a rate of $165 per mile. As with question 4, assume FHP would agree to pay $2.20 per mile if Over-land would sign a five-year contract. Further, assume Over-land 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 salaries such as billing. How many annual miles are required for Over-land to break even if the miles are outsourced? What is the expected annual increase in profitability from the FHP contract? What are your conclusions? 6 a. Why might Over-land use an independent operator if the variable cost per mile is higher than if the company had purchased a rig and hired a driver? b. 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? Exhibit 1 Income from Operations (All financial information in the case has been scaled and disguised for educational purposes.) Over-land Trucking and Freight Income from Operations For the year ending December 31, 2013 E 12/31/2013 $20.975.280 4.950.160 Revenue Line Haul Fuel Surcharge Miscellaneous Total Revenue 450.120 5.375,570 Variable Expenses 675,120 Oil Lubricants Tolls Parts and Small Tools Hourly Wages Drivers Trailer Poot Expense Total Vanable Fixed Expenses Insurance Generaliability Physical Damage K o ht to page 1 Page view A Fixed Expenses Insurance General Liability Physical Damage Workers Compensation Health Insurance Security Depreciation Salaries, Benefits (Garagel Salaries, Benefits (Office) Bad Debt Expense 112,620 225.010 226,000 224,500 111,750 2.137.500 675.000 1.012,520 113.500 Permits 111.520 Rental Equipment Payroll Taxes Accounting Fees, Supplies, Computer Maintenance Miscellaneous Total Variable 1.013.000 562.500 112.350 337.510 6.975,280 Income from Operations $3 621 810 - + Fit to page Page View l A Red Exhibit 2 Over-land Balance Sheet Over-land Trucking and Freight Balance Sheet For the year ending December 31, 2013 Assets Current Assets Cash Accounts Receivable $200,000 300,000 $500,000 Total Property Plant and Equipment Land Buildings Accumulated Depreciation Buildings Tractors, Trailers, and Equipment Accumulated Depreciation 1.000.000 1000000 1.250.000 18.650.000 $16.650.000 Total $17,150.000 Total Assets tid Eni Liabilities and Equity Current Liabilities Accounts Payable Taxes Payable Current Portion of Long-Term Debt Total Current Liabilities 150,000 65,000 35.000 $250.000 Long-Term Liabilities Notes Payable 1865.000 SHRI Total Long-Term liabilities 1:5000 Total liabilities 36VOCE 148000