Marginal seventh vehicle: full-cost and break-even appraisal
A haulier operates six tractor units and has an opportunity to put a seventh vehicle on a dedicated contract: 95,000 km a year at EUR 1.38 per km. The new tractor unit costs EUR 92,000; it will be kept for five years and sold for an estimated 15% of cost. The haulier will finance it with a five-year loan; first-year interest is budgeted at EUR 2,700. Annual fixed costs for the vehicle are insurance EUR 5,800, road tax EUR 1,200, driver EUR 42,000 including employer on-costs, trailer lease EUR 6,000 and an allocation of overheads EUR 9,500. Variable costs are fuel EUR 0.34/km, maintenance EUR 0.11/km and tyres EUR 0.03/km. The contract guarantees the distance but not a fuel escalator. The finance director is concerned that the margin is thin and that a 5% shortfall in distance or an 8% fuel price rise would wipe out profit. The company uses straight-line depreciation.
1. Calculate the annual full cost, cost per kilometre and profit at 95,000 km. Show fixed and variable elements.
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Depreciation: (EUR 92,000 - 15% residual of EUR 13,800) / 5 = EUR 15,640 a year. Fixed costs: depreciation 15,640 + interest 2,700 + insurance 5,800 + road tax 1,200 + driver 42,000 + trailer lease 6,000 + overhead 9,500 = EUR 82,840. Variable cost: 0.34 + 0.11 + 0.03 = EUR 0.48/km. At 95,000 km variable cost is EUR 45,600. Total annual cost = EUR 128,440. Cost per km = 128,440 / 95,000 = EUR 1.352. Revenue = 95,000 x 1.38 = EUR 131,100. Profit = EUR 2,660, a margin of about 2.0%. The calculation shows a very thin margin; the overhead allocation may be an accounting charge rather than incremental cash, but it is still relevant to the full-cost decision.
2. Calculate the break-even distance and test the contract against a 5% distance shortfall combined with an 8% fuel price rise. What recommendation follows?
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Break-even distance = fixed costs / contribution per km = 82,840 / (1.38 - 0.48) = 92,044 km. At 95,000 km the contract is only 2,956 km above break-even. With a 5% shortfall, distance is 90,250 km. Revenue is 90,250 x 1.38 = EUR 124,545. Base variable cost is 90,250 x 0.48 = EUR 43,320; total cost EUR 126,160; loss EUR 1,615. With an 8% fuel rise, fuel becomes 0.34 x 1.08 = EUR 0.3672/km; variable rate becomes 0.3672 + 0.11 + 0.03 = EUR 0.5072/km. Variable cost = 90,250 x 0.5072 = EUR 45,775; total cost = EUR 128,615; loss = EUR 4,070. To break even at 90,250 km the price would need to be 128,615 / 90,250 = EUR 1.425/km before any profit. Recommendation: do not accept at EUR 1.38 unless the customer accepts a fuel escalator, a minimum-distance guarantee, or a higher rate; otherwise the contract transfers cost risk to the haulier for negligible reward.
3. Apart from the arithmetic, what cash-flow and commercial factors should the board consider before signing?
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Cash flow: the tractor unit and loan repayments fall due before customer receipts; check the deposit, repayment profile and whether the contract pays monthly in arrears. Residual value: a 15% residual after five years is an assumption, and a weak used market would raise depreciation. Commercial: driver availability and wage inflation; customer credit risk and termination rights; whether the overhead allocation is truly incremental; maintenance risk as the vehicle ages; insurance and claims record; and the opportunity cost of using the O-licence margin for this contract. The board should also test a scenario where the vehicle is off the road and a replacement is hired, and confirm that the contract does not require a service level the fleet cannot meet. A sensitivity table, not a single point estimate, should support the decision.