Posted: August 8th, 2016

What is a carnage cover?

Mr. Carter is the manager of Simmons Farm and Seed Company, a wholesaler of fertilizer, seed, and other farm supplies. The company has been successful in recent years primarily because of great customer service, flexible credit terms, customized orders (quantities, seed mix, etc), and on-time delivery. Global Agricultural Products, Inc., Simmons’ parent corporation, has informed Mr. Carter that his budgeted net income for the coming year will be $120,000. The budget was based on data from the prior year and Mr. Carter’s belief that there would be no significant changes in revenues and expenses for the coming period.

After the determination of the budget, Carter received notice from Simmons’ principal shipping agent that it was about to increase its rates by 10%. This carrier handles 90% of Simmons’ total shipping volume. Paying the increased rate will result in failure to meet the budgeted income level. Mr. Carter is understandably reluctant to allow that to happen. He is considering two alternatives. First, it is possible to use another 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 $70,000.

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

As a second alternative, Simmons can purchase its own trucks thereby reducing its shipping costs to 85% of the original rate. The new trucks would have an expected life of 10 years, no salvage value and would be depreciated on a straight line basis. Related fixed costs excluding depreciation would be $2,000. Assume that if Simmons purchases the trucks, Simmons will replace the principal shipper and the other shippers.

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