UCLA Certified Freight Lines Case Study Discussion

Econ 137A-W20
Optional take-home final exam
Certified Freight Lines case study
Friday, March 20
1
Do your own work. Use Word and Excel. Label/tag each document with your name (last name first.) No
links—send as attachments. No PDFs. Return to me at loster5@cox.net by 11am on Friday, March 20.
(IMA adapted)
INTRODUCTION
Alan James founded Certified Freight Lines in 1968 and has grown the business into a sizeable operation
with 90 trucks and 180 trailers. His largest customer, FHP Technologies, has submitted a proposal to him
to add delivery routes that would improve the efficiency of FHP’s supply chain. Alan was not certain that
Certified could handle the additional routes since the company currently was operating at (or near) full
capacity.
FHP offered a total of $2.15 per mile (including fuel service charge and miscellaneous fees) for the new
route. But Alan knew that to accept the offer he would have to add more trucks and perhaps incur
additional debt. The question was whether the rates offered by FHP were high enough to offset the
associated risks of growing the fleet. Although the business had been grown organically through the
years by reinvesting profits, it incurred debt from time to time to replace older equipment (usually in
blocks of five trucks). Alan knew the slim profit margins associated with trucking, coupled with a
downturn in the economy, could spell disaster if saddled with too much debt. See Exhibit 1 for the
company’s most recent statement of income from operations.
Management at FHP has asked Certified to consider adding two dry van loads per week; each load
would require 1,500 round-trip miles. Because FHP is a long-term client with a strong financial position,
the company’s management has asked for a very favorable rate of $2.15 per mile. Alan believes the
potential volume of freight from FHP can be used to grow Certified’s business and profitability. There is
also risk associated with not taking the new lines. If Certified does not accept the new routes, another
trucking line will, thus building loyalty with FHP.
THE PROPOSAL
FHP is a stable, solvent company that presents no question of collection, thus ensuring a reliable cash
flow. If FHP decides to restructure its supply chain in the future, Certified could find itself in the
undesirable position of holding dedicated assets (trucks and trailers) for routes that no longer exist. The
owner’s aversion to increased debt levels further exacerbates concerns about acquiring additional fixed
assets. Perhaps Certified could service the initial demand with existing equipment. But, as additional
routes are added in the future, Certified must acquire more tractor-trailer rigs or consider outsourcing
the miles by using independent contractors.
Exhibit 1 presents Certified’s income from operations for the year ending December 31, 2013.
Econ 137A-W20
Optional take-home final exam
Certified Freight Lines case study
Friday, March 20
2
EXHIBIT 1
Certified Freight Lines
Econ 137A-W20
Optional take-home final exam
Certified Freight Lines case study
Friday, March 20
3
THE DECISION
1. 10 points Assume Certified 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. 10 points Calculate the contribution per mile and total annual contribution associated with
accepting FHP’s proposal. (Use 52 weeks per year in your calculations.)
3. 20 points After a closer examination of capacity, management believes an additional rig is
required to service the FHP account. Assume Certified’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 if Certified would sign a five-year contract. What is the
annual number of miles required for Certified 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.)
4. 20 points Certified 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 Certified’s most reliable independent contractors has quoted a rate of
$1.65 per mile. As with question 3, assume FHP would agree to pay $2.20 per mile if Certified
would sign a five-year contract. Further, assume Certified 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 Certified to break even if the miles are outsourced? What is the expected
annual increase in profitability from the FHP contract?
5. 40 points Prepare a recommendation to management. Use information from your answers to
questions 1–4 in your analysis. Clearly state and support your recommendation. Be thorough.
Consider both quantitative and qualitative factors. Be beefy. Use good form.