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Starfire Company’s Strategic and Financial Analysis Case Study

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Updated: May 29th, 2020

Introduction

Starfire is a trucking company that has been in the business for over 40 years. This company is faced with an exciting opportunity of obtaining additional benefits from doing business with one of its major customers, FHP. Management is now in a dilemma of whether or not to take on a new deal. The decision regarding this deal is crucial for the company as it affects capacity, strategy, and finances as well. In this paper, the researcher considers the three financial options available to Starfire if they decide to accept FHP’s offer. The paper also looks into the strategic impact of either decision. Additionally, the paper considers the issues of capacity. Finally, we give a recommendation to management on this matter.

Financial Analysis

Starfire has three options to service FHP’s requirement. The analysis below explains the impact of each of the three options on Starfire’s profit.

Option One

The first option entails Starfire making use of its existing trucks to fulfill customer needs. The company has a few extra trucks that are idle. Their purpose is to replace any working truck that breaks down, which helps avoid delays and increase customer satisfaction. Option1 will not require any immediate capital expenditure. It is attractive because management is not keen to add more debt to the balance sheet. The table below shows the income Starfire would get assuming management would pursue this option.

Annual Income Expected From FHP Contract (Option 1)
2 Round trips weekly @1,500 miles per trip =3,000 miles
Each mile @ $2.2 = 6,600
Full year gross income @ 52 weeks = $343,200
Less Variable costs @ 1.39 per mile =216,840
Net Income = $126,360
Percentage increase in annual profit = 3.43%

The assumption here is that Starfire will not incur any capital expenditure. However, it will continue to incur the average variable costs as usual. This figure ($1.39 per mile) is obtained from the income statement. Therefore, after deducting the variable expenses, the company will gain $126,000.

Option Two

The second option entails purchasing one truck to help meet FHP’s needs. The company will assume that it will be able to optimize its existing trucks to obtain the second truck. The first truck will most likely be purchased on credit, hence increasing the company’s debt. The estimated annual cost for acquiring the truck is $50,000. Should Starfire pursue option two, the table below shows the expected income.

Annual Income Expected From FHP Contract (Option 2)
Full year gross income @ 52 weeks = $343,200
Less increased cost of acquiring new equipment = $50,000
Less Variable expenses = $216,840
Net Income = $76,360
Percentage increase in annual profit = 2.07%

As in the first option, we assume that as the company will be operating the truck itself, it will continue to incur the usual average variable costs of $1.39 per mile. Upon deducting the variable costs and the cost of expanding capacity, Starfire will earn a net income of $76,360 if management chooses this option.

Option 3

Option 3 involves bringing on board independent contractors, which will help Starfire expand capacity without having to purchase an additional truck. Thus, the company can achieve its objective but avoid taking on extra debt. The table below shows the income Starfire would expect to obtain if management pursues option 3.

Annual Income Expected From FHP Contract (Option 3)
Full year gross income @ 52 weeks = $343,200
Less money paid to independent contractor @ $1.65 per mile ($257,400) = 85,800
Less incremental fixed costs = $20,000
Net Income = $65,800
Percentage increase in annual profit = 1.79%

Though Starfire will not acquire an additional truck, this option comes with incremental fixed costs amounting to $20,000. The independent contractors also have to be paid per mile. Their asking price is $1.6 per mile. Thus, Starfire will actually make only $0.55 per mile on this contract. After deducting the associated expenses, Starfire will earn $65,800 if management pursues option 3.

Capacity Analysis

Capacity analysis for Starfire involves the evaluation of the productivity of all the business resources. Usually, companies aim at maximum efficiency, hence maximum capacity utilization. In this case, capacity includes the trucks, trailers, and drivers (Kline, Liao & Schiff 2013) which are the machinery the company uses to provide services to its customers. Currently, the company already owns 90 trucks and 180 trailers. The capacity utilization is at 85% now.

Unfortunately, it is difficult to attain 100% efficiency because operations are never perfect. There are customer delays, traffic, accidents and rigs breakdown. Starfire’s management is not keen on obtaining additional debt for capacity expansion, which means that they need to carry out an evaluation of the current capacity. The objective is to ascertain if they can meet FHP’s needs without incurring additional debt.

There are several opportunities open to Starfire to expand its existing capacity. First, the company’s policy of assigning one driver to one truck could be reviewed for five trucks. The review means that the truck can work double the current time as a new driver takes over after each shift. If five trucks are moved to this system, Starfire can buy itself additional time, hence extra capacity that can be used to fulfill FHP’s order. Secondly, at 85% efficiency, we assume that Starfire has an extra 14 trucks on standby in case a rig breaks down. The company has an opportunity to allocate two of these trucks to FHP’s new order and hire other in case of breakdowns. If Starfire takes care of the rigs in use properly, there may be no need to hire any extra truck. The remaining 12 can be the backup trucks.

Strategic Analysis

Whichever decision Starfire takes regarding this issue, it will greatly affect its future business with FHP. First, if Starfire takes on the additional trips, it will make FHP more dependent on them as a supplier. FHP Technologies may even consider outsourcing the whole supply chain department to Starfire. Consequently, Starfire will increase its revenue. Currently, whichever option of capacity expansion the company pursues, it will gain between 1.79% to 3.4% increases in profits.

Management could also decide to forfeit this new business. The implication is that FHP will need to get a new supplier to ply the new routes. The risk here is that a new supplier may offer better services or rates than Starfire that may lead to FHP opting to use a new supplier for all its routes. Starfire considers this result to be quite undesirable given that FHP is one of its biggest customers.

Supposing the company decides to expand capacity, there are strategic considerations as well. James is clearly not for the idea of more debt because the economy is on a slowdown. More debt puts the company at higher risk unless it was able to repay. However, using independent contractors as well puts the company at reputation risk. Relational risk is worse than debt risk because it could cause FHP to terminate the whole contract because of poor services. On the other hand, refusal to expand to these new routes exposes FHP to competition. In a slow economy, companies need to defend their business to avoid losing to competition.

Executive Summary and Recommendation

Starfire has received an offer from its biggest customer to provide additional trucking services on new routes. The offer requires two extra trucks that will do 1,500 miles each week. FHP is willing to pay $2.2 per mile for these additional services. Financial analyses show that whichever capacity expansion method Starfire chooses, it stands to gain incremental profits. However, the best option would be to optimize its current fleet to get the two extra trucks.

Capacity analysis also reveals that it is possible for Starfire to optimize its current fleet by employing new strategies. Drivers can work in teams to ensure maximum truck utilization. Starfire can assign two of the spare trucks to FHP. Strategic analysis also shows that the most desirable option is to take up the offer. Failure to do so exposes the company to competition.I would recommend that Starfire takes up FHP’s offer and services it by optimizing its current fleet, which will result in profit gain for the company and avert competition. The company can also maintain its service quality by controlling drivers and trucks.

Reference

Kline, S., Liao, W. &Schiff, A. (2013). Cost accounting for managerial planning, decision making and control.Sydney:Cognella Academic Publishing. Web.

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