Question

1 Mercer Farms, Inc. As a junior analyst for Mercer Farms (Mercer), you were looking forward to an exciting career. You imagined assignments evaluating new technologies in far-off, exotic locations. As your bus traveled through the heartland of U.S. cornfields, you wondered about your job choice. Your background research, however, has changed your first impression of being assigned to an agricultural consulting engagement. You have discovered that farming is no longer a small potatoes operation. Perhaps, given the changes in the size of farming businesses in the U.S., agribusiness might be a lucrative consulting specialty. Mercer Farms Inc. (hereinafter referred to as Mercer Farms) is an old, family-owned business that has acquired various smaller farms over the years and has managed to maintain a profitable business enterprise through economies of scale. So far, the firm has specialized in the production of Grade AA yellow corn. Michael Bell, Operations Manager for Mercer Farms, has proposed replacing the current production of AA yellow corn with a new genetically modified (GM) variety of yellow corn (see Exhibit 1). Allen Mercer, CEO of Mercer Farms, engaged Mercer to evaluate Mr. Bell’s proposal and make recommendations. The firm’s research staff has pulled together information regarding the new product (see Exhibit 2) and the past two year’s income statements for Mercer Farms (see Exhibit 3). Your team has a few days to review the materials and prepare its preliminary analysis before meeting with the client. Required Prepare a business report to the client setting forth your team’s analysis and recommendations. In the report, address any risks associated with the recommendations. The team will also deliver its analysis and recommendations in a formal, personal presentation to the client. You may wish to review microeconomics concepts 1, 2, and 4; management accounting concept 8, and statistics concept 8. The Exhibits follow on the next pages.  Copyright 2009, Richard Tontz Thanks to Dr. Janice Bell for her assistance with the accounting aspects of the case. 2 Exhibit 1: Bell Proposal Letter Mercer Farms Inc. 17342 Mendow Circle, San Jose, CA 95129 Phone (408) 555-CORN January 10, 2009 Mr. Allen Mercer 124 East Ocean Ave. Santa Barbara, CA 93105 Dear Uncle Allen: As we discussed last fall, I have been looking into switching the company’s output from Grade AA yellow corn to a new strain of Genetically Modified (GM) yellow corn. I think you will be pleased with the following results of my analysis and the potential impact on our profitability. Output and Revenue Analysis: Based on our output from last year, if we plant Grade AA yellow corn again we can anticipate: Total Revenue (TR) = $ 1,450,000 (290,000 x $ 5.00) If we switch to the new genetically modified (GM) yellow corn: Total Revenue (TR) = $ 2,653,750 (482,500 x $ 5.50) As you can see, our output would increase and the GM yellow corn is of somewhat higher quality generating a higher anticipated price. This change would increase output by 192,500 bushels or 66% and increase TR by $ 1,203,750. Cost Analysis: Our average production cost was $ 2.48 per AA yellow corn bushel this past year. We estimate it will be $ 2.70 per AA yellow corn bushel this year. If we switch to GM yellow corn, our processing, overhead and planting expenses will not change, but the increased price of GM yellow corn seed will raise average production cost per bushel to $ 3.25. AA yellow corn Cost: 290,000 x $ 2.70 = $ 783,000. GM yellow corn Cost: 482,500 x $ 3.25 = $ 1,568,125. Increased Cost: $ 785,125 Profit Analysis: Increased total revenue = $ 1,203,750 Increased cost = $ 785,125 Increased profit: $ 418,625 Total Profit: $ 1,085,625 I hope you are as excited about this potential as I am. There has been some bad press about the genetically modified products in Europe, but I think that’s just the usual fear of new technologies. Sincerely; 3 Michael Michael P. Bell Operations Manager Mercer Farms Inc. Exhibit 2: Estimated Production by Farm Projected Year 2009: Production Summary for AA Yellow Corn by Sub-division: 1. Adams: 200 acres 20,000 bushels (100 per acre) 2. Baker: 500 acres 50,000 bushels (100 per acre) 3. Chase: 300 acres 60,000 bushels (200 per acre) 4. Dotson: 800 acres 160,000 bushels (200 per acre) 5. Mercer Farms Total: 1,800 acres 290,000 bushels AA yellow corn Projected Year 2009: Production Summary for GM Yellow Corn by Sub-division: 1. Adams: 200 acres 22,000 bushels (110 per acre) 2. Baker: 500 acres 50,500 bushels (101 per acre) 3. Chase: 300 acres 90,000 bushels (300 per acre) 4. Dotson: 800 acres 320,000 bushels (400 per acre) 5. Mercer Farms Total: 1,800 acres 482,500 bushels GM yellow corn Exhibit 3: Mercer Farms: Income for the Two Years Preceding 2009 1st Prior Year 2nd Prior Year (Last Year) (Year Before Last) Sales and Changes in Value of Crop Inventories $1,254,250 $1,160,181 Expenses and Losses Cost of Production 720,360 677,138 Selling, General, and Administrative Expenses 313,200 269,352 Technological Expenses 93,960 79,866 Other 11,745 10,336 Income From Continuing Operations Before Taxes 114,985 123,489 Income Taxes 32,196 34,577 Net Income $82,789 $88,912 Basic Earnings Per Share $0.32 $0.35 4 Exhibit 4: Marketing and Price Analysis Mercer Farms Group - Marketing Division Background: The Marketing Division was asked to analyze the expected prices and probabilities for AA yellow corn and Genetically Modified (GM) yellow corn for the summer harvest. Analysis: Estimating the future demand and supply of the commodity derives the projected market prices. The factors considered in the demand portion of this analysis include population growth, consumer preferences, and income. Relative prices of substitutes and complements were considered as static or unchanged. The supply portion of the analysis considered current input prices, existing technology, existing stocks on hand (domestic and foreign), and government policies (domestic and foreign). Exchange rate estimates were taken from our International Division’s current forecast. Price Forecast: AA Yellow Corn (domestic): Price per bushel: $ 5.00. GM Yellow Corn (domestic): Two alternative price scenarios should be considered. The demand acceptance of GM products in general is in question. There have been numerous reviews by governments all over the world, but particularly in Europe.  Scenario #1: Price of GM Yellow Corn (domestic): $ 5.50. Europe adopts few restrictions on the importation of GM products, but prohibits European production.  Scenario #2: Price of GM Yellow Corn (domestic): $ 4.70. Europe adopts heavy restrictions on the importation of GM products. At this time, we consider the probabilities to be: Scenario #1: 60%; and Scenario #2: 40%. The futures markets will have determined which price will occur before it is time to plant the summer crop.

Answer 1

Business report regarding replacing the production of Grade AA yellow corn crop with Genetically Modified (GM) yellow corn by Mercer Farms

A few parameters to be considered while changing the cropping pattern can be as follows:

1) Experience in the given business : The firm has rich experience in the given field of production of yellow corn so its a favorable aspect of the proposal.

2) Financial paratemeters : Here we see that increase in cost of production per bushel if we change to GM yellow corn is $ 0.55 which amounts to total rise in cost of production by $ 785,125. Further if we cosider the cost of availing finance for this additional cost say at 8% per annum the actual additional cost would be 1.08 * =$ 847,935 and thus actual increase in profit as per above calculation would be $ 355815.

The sale price of GM yello corn is shown as $ 5.5 which has probability of 60% and $ 4.7 which has probability of 40 % so if we want to have a better decision we need to weigh both the probilities so the probable sale price of GM yello corn can be $ ( 5.5*0.6 + 4.7*0.4 ) =$ 5.18 Further we consider the sale price of 5.18 our total revenue will be $ 2,499,350 and incresed profit $ 264,225. Besides this when cost of availing finance is considered the increased profit comes down to $ 201,415.

3) Technical Aspects : Here the expectations on yeild from GM yellow corn is kept quite high as follows: (a) for Adems the production is expected to change from 100 bushels per acre to 110 bushels per acre (b) for Baker the production is expected to change from 100 bushels per acre to 101 bushels per acre (c) for Chase the production is expected to change from 200 bushels per acre to 300 bushels per acre and (d) for Dutson the production is expected to change from 200 to 400 bushels per acre which seems a bit not justifiable to if we consider on an average rise in production at 40% we will get the production of GM yellow corn for next year 406,000 which will yield revenue of $ $ 2103080 if sold at $ 5.18. Further if we consider the cost of finance i.e. $ 62858 and keeping the cost of same i.e. $ 1568125, we get the total profit as $ 534955 and which is decline in profit of $132045.

4) Managerial Aspects : The change in production would need additional cost which is not considered in the given exhibits.

Given the above mentioned facts following risks should be considered while chaning the production.

1) Market acceptance : The strong evidence should be considered that new product would be well accepted in the market.

2) Sales arrangmenet : The firm must have the disrtibutors / purchasers into confidence before changing the pattern.

3) Legal requirment : For GM yellow crop all the necessary clearances if any need to be obtained and the associated cost for the same need to be considered.

4) Competitors study : A study needs to be carried out if there are other firms in the production of GM yellow corn and suitable base for such study needs to be established.

Recommandtions : Considering the factors like cost of additional finance needed, basis of enhanced production with GM, market acceptance and rationlization of sale price as mentioned above the changing production to GM yellow corn is not advisable at present as it will lead to decline in the existing profit as mentioned under Financial parameters.