case study exercises case 4 farming …starrygoldservices.com/icanknow16/icancsmaywk4qa.pdfcase 4...

STARRY GOLD ACADEMY +2348023428420, +2347038174484, [email protected] , www.starrygoldacademy.com

CASE STUDY EXERCISES

CASE 4

FARMING SUCCESS LIMITED

INTRODUCTION

Farming Success Limited is an agricultural private limited liability company, engaged in the production of Special Palm Oil (SPO). The company

was established 25 years ago by a group of private promoters. It purchased a total of 10,000 hectares of farmland from some families in a local

community. The company has developed 60% of the land and the palm trees are fully matured. The remaining 40% of the land is not yet developed.

The company had been doing well since the planted area matured. The financial statements for the past five years are contained in Appendices 1 and

2. The company had been able to get sufficient labour for its various operations from the local community.

The gestation period for the type of palm trees planted is a minimum of five years and by the beginning of the sixth year of existence, the company

had started to produce Fresh Fruit Bunches (FFB) for sale. The production schedule of FFB since the company's plantation matured is contained in

Schedule 3. The company commenced the processing of its FFB in the seventh year of its existence. The company had devoted its resources mainly

to the production of SPO, hence it did not acquire a palm kernel crushing plant along with the palm oil processing mill.

The company's SPO had enjoyed a very good market, with a market share of about 30%. There are seven other companies in the industry, of which

four are quoted. The buyers of the company's SPO usually pay (between four to six weeks) in advance before any supply is made. This system

provides a good source of working capital for the company. Though the company is a private limited liability company, it compares favourably with

quoted companies in the industry in terms of turnover and profitability. The average P/E ratio of a good quoted company with stable earnings and

dividend for several years in the industry is 9.5 while that of Farming Success Limited is 9.8. The shareholders have not been willing to get the

company quoted so as not to dilute the ownership structure.

The company's operations are seasonal. The main season is usually from February to May and the light season runs from September to November.

The company must take advantage of the main season in order to ensure that sufficient cash is realised to be able to operate during the off-season.

The company, during its early years of operations, when the palm trees had not matured made use of casual labour, it was discovered when SPO

processing started, that the system of using casual labour was inadequate.


Since the peak period coincides with the land preparation for local farming activities, it becomes difficult for the company to get sufficient labour

during the peak period. To retain its labour force throughout the year, the company makes effective use of its labour for plantation upkeep during the

off-season. The company also has a policy of retaining any casual labourer who has worked conscientiously for a period of one year.

In the early years of SPO processing, the company made it a policy to grant an annual scholarship award to indigenes of the community from which

the land for the plantation was purchased. The company also assisted on some community development projects and strived to give indigenes

preference in the recruitment of personnel.

In view of the good relationship, the community seven years ago, indicated its intention to give more land to the company for its expansion

programme when the 4,000 hectares are fully developed.

The shareholders of the company had been declaring 80% of its distributable profits as dividends for the first five years and ploughing back the

balance. The amount ploughed back had been invested on purchase of posh cars for the directors and top management of the company. Very little

amount was invested in agricultural equipment which had been a limiting factor for the effective harvesting of the FFB needed for the production of

the company's product.

MARKET SITUATION

Usually, the customers of the company had to pay four to six weeks in advance for any purchase. The company, being in a sellers' market, had always

passed any increase which may be due to inefficiency in its operations to the customer. The demand for the company's product is fairly inelastic.

Considering the present state of encouragement by the government for investment in palm plantation and the ever increasing foreign exchange rate

which has made it unattractive to import SPO or its substitutes into the country, the company could still enjoy this fairly inelastic demand for the next

few years.

Currently, as a result of the problems listed below, the company's customers may have to pay three months in advance for any supplies:

(a) Incessant breakdown of the mill which is now aging;

(b) Low extraction ratio due to inefficiency of the mill;

(c) Low staff productivity due to low morale; and

(d) Inability to procure spare parts in time for the mill and other farm equipment due to liquidity problems.

Recently, a customer, Faith Palm Products Limited (FPPL) paid for 150 tonnes of SPO at N50,000 per tonne. The supply had been delayed for four

months. The company increased its price to N65.000 per tonne and Faith Palm Products Limited was requested to pay an additional N15.000 per

tonne before supply could be made to it.


The company had also offered to refund N7.5 million paid by FPPL if the latter could not afford to pay the additional N15,000 per tonne. FPPL had

taken the company to court to press for the supply at the price demanded and for which it had paid.

STAFF DEVELOPMENT

The company has a total work force of 500, of which 150 are casuals. In the past, the usual labourers were converted to permanent staff after a year's

service but at present there is no such opportunity, as casual labourers are laid off during the off season. Rather than making use of them for the usual

farm upkeep, contractors are mow used for farm upkeep. These contractors are connected persons to top management. In most cases, the contracts

were poorly executed but were paid for. These contractors, in most cases, made use of the laid off casual labourers.

The remaining 350 permanent staff are in the following cadres:

Top management 4

Senior management 21

Middle management 30

Supervisory 50

Junior 245

350

Most staff do not attend any staff improvement courses or training programmes except members of top management and a few favoured staff in the

senior and middle management cadres. The junior staff cadre does not enjoy any training opportunity at all.

MANAGEMENT STRUCTURE

The management of the company is headed by a Managing Director who holds a first degree in physiotherapy. He-is a cousin of the Chairman, a

major promoter of the company. The Executive Director (Finance) has an Ordinary Diploma in Accounting. He rose through the ranks to this

position. He enjoys good rapport with the Managing Director. He is fond of telling the Managing -Director any adverse comments by any other

management staff. The Executive Director (Operations) is a specialist in the field of agriculture. He has a good knowledge of the industry but his


performance was impaired as the Managing Director and the Finance Director did not co-operate with him. Most equipment needed for effective

operations are always not provided. The Executive Director (Technical) holds a Diploma in Automobile Engineering. He was recruited 15 years

ago to take charge of the Mechanical Workshop. He rose to the present position a year ago through the assistance of his in-law, who is related to a

Director and one of the promoters of the company. The former Technical Director who holds a degree in Production Engineering and Masters

degree in Business Administration was frustrated out of the company. His problem started when he advised that the company be prudent by setting

aside funds for the refurbishment or replacement of the mill rather than encouraging the shareholders to distribute almost all the profits.

CURRENT PROBLEMS OF THE COMPANY

The immediate problems of the company are as follows:

( a ) The company is currently experiencing a liquidity crisis arising from low production of SPO. Delays in supplying customers had discouraged

many from making advance payment which had been a good source of working capital in the past.

Management had estimated that the company would need N5 million to buy essential spare parts for the mill. This amount would sustain the

mill till a major refurbishment or replacement would take place which should not be later than a year if the company is to avoid a complete

shutdown. It would take three months before any repayment can be made from the sales proceeds. The company could not raise the funds

from its bankers as it could not service its present commitments.

The agricultural loan of M25 million taken 5 years ago for the planting of undeveloped land was diverted to the construction of a

sophisticated office complex in the plantation. The loan has a three-year moratorium. The principal has net been repaid at all and the loan has

not been serviced effectively.

The two options now available to get the funds required for the spare parts are:

(i) To borrow from a local finance company at an annual interest rate of 42%. The repayment of capital will start after three months and

will be spread equally over three months.

(ii) The spare parts could be obtained at exhorbitant prices from a supplier who is ready to supply the parts needed on credit or for cash.

The supplier is ready to allow six months credit.

(b) There is an urgent need to refurbish the mill within the next one year. The repairs to be carried out as a result of the problem listed above is

only a temporary measure. The mill should be replaced as it has become technologically obsolete. The cost implications of refurbishing and

replacing the mill are contained in Schedules 4 and 5.

(c) The company had been selling its uncracked kernel to local mini kernel crushers, but substantial revenue is lost in this process. In the light of

these, the company planned to purchase a palm kernel crushing plant. The production of palm kernel will require three grades of labour.

Grades 1 and 11 will have to be recruited at the inception of operating the palm kernel crushing plant. Grade 111 labour is available in the

company and they are currently not engaged. They are being retained because their services will be required in a year's time when the


company's planting programme is expected to have fully matured. It is reckoned that by this time the company will recruit Grade III labour for

the palm kernel plant, if acquired.

The cost implications of buying and running the palm kernel crushing plant are contained in Schedule 6.

(d) Due to the current financial crisis, the company had stopped granting scholarships to deserving indigenes and had not aided any community-

based project in recent times. This situation had generated a lot of bad feelings from the host community.

(e) The company is presently experiencing a serious encroachment problem on its undeveloped land. The local farmers have recently gone to the

extent of planting permanent cash crops on the land. The recent inability of the company to aid the community on its development projects

had reduced the support being given by the chiefs and leaders of the community who had been preventing their subjects from encroaching into

the company's farmland.

The company would need to plant 1,500 hectares within the next three years, in order to stop the community from encroaching on its

property. Failure to plant may result in the community taking over the property completely. Any attempt to dislodge any trespassers could

lead to crises.

The cost implications of planting the 1,500 hectares are given in Schedule 7. The planting may be spread over three years at 500 hectares per

annum.

FUTURE PLAN

Apart from solving the immediate problems, the company is proposing in the medium term to:

a) Plant the remaining 2,500 hectares if it is able to plant the 1,500 hectares in an area prone to encroachment within the next three years; and

b) Produce refined palm kernel oil which is enjoying increased demand and can be a good foreign exchange earner for the company.

MANAGEMENT CONSULTANCY

The company has commissioned its external auditors to look into its problems and recommendations for solving them. They had been auditing the

company's financial statements for the past 15 years and the audit constitutes 50% of their see income. The firm has good rapport with the

management. The top management had intimated the auditors that the shareholders would not like the company to go public in order to avoid dilution

of the present ownership structure and that the current shareholders may not be able to inject further funds into the company.


SCHEDULE 1


FIVE-YEAR BALANCE SHEETS AS AT 31 DECEMBER

2000 1999 1998 1997 1996

N’000 N’000 N’000 N’000 N’000

Paid up share capita! 25,000 25,000 25,000 25,000 25,000

Long term Loan 25,000 25,000 25,000 25,000 25,000

Profit and Loss Account 36.500 33.000 26.000 20,000 16.000

86.500 83.000 76.000 70.000 66.000

Represented by:

Fixed assets 88.750 79.500 73.400 64,370 61.000

Current Assets:

Stock of spare parts 2,000 4,000 3,500 6,500 7,000

Trade debtors 1,500 1,200 1,750 950 1,050

Pre payment 750 1,050 600 800 720

Cash and bank balances 4,500 3,750 2,860 3,450 2,770

Less: Current Liabilities (11.000) (6.500) (6.110) (6.070) (6,540)

Net current assets (liabilities) (2,250) 3,500 2,600 5,630 5,000

86.500 83,000 76.000 70,000 66.000


SCHEDULE 2


FIVE-YEAR INCOME STATEMENTS FOR

THE YEAR ENDED 31 DECEMBER

2000 1999 1998 1997 1996

N'000 N'000 N'000 N'000 N'000

Turnover 346,000 378,000 313,100 304,000 300,300

Cost of production (211,060) (215.460) (172.000) (158.080) (154.150)

Gross profit 134,940 162,540 141,100 145,920 146,150

Administrative and

Distribution expenses (109.940) (112.540) (98.243) (117.169) (123,150)

Other income 2,000

Profit before tax 25,000 50,000 42,857 28,751 25,000

Tax (7,500) (15.000) (12.857) (8.751) (7.500)

Profit after tax 17,500 35,000 30,000 20,000 17,500

Dividend (14.000) (28.000) (24.000) (16.000) (14.000)

rRetained profits 3,500 7,000 6,000 4,000 3.500


SCHEDULE 3


20 YEARS FRESH FRUIT BUNCHES (FFB) PRODUCTION SCHEDULE

Year FFB Production (in tonnes)

2000 51,000

1999 54,000

1998 55,000

1997 59,000

1996 61,000

1995 72,180

1994 72,000

1993 72,850

1992 71,000

1991 60,000

1990 72,000

1989 72,500

1988 71,500

1987 71,190

1986 73,150

1985 70,500

1984 72,205

1983 72,000

1982 54,000

1981 36,000

Note: The palm trees were expected to achieve the standard production of 12 tonnes of FFB per hectare by year 1984 and the normal standard should

be maintained for the next 20 years.


SCHEDULE 4 FARMING SUCCESS LIMITED COST DATA FOR MILL

REFURBISHMENT

Cost of refurbishment N150,000,000

Life span of refurbished Mill 5 years

Salvage value N 30,000,000

Production capacity (SPO) p.a. 10,000 tonnes

Production cost per tonne of SPO other than FFB:

Labour N 1,200

Material other than FFB N 4,800

Fixed overheads of which depreciation comprises 40% N 4,000

Selling price per tonne N 65,000

Value of the Mill if sold now N 20,000,00

Notes:

(i) Necessary farm upkeep operations would be carried out to bring production to normal standard of 12 tonnes of FFB per hectare.

(ii) The total planted and mature area is 6000 hectares

(iii) Production of FFB will increase every five years by 20% due to maturity of new planting.

(iv) FFB not processed could be sold for N6,000 per tonne. The refurbishment could be carried out every five years at a cost of N150 million for

each refurbishment.

(v) The refurbishment cannot be carried out for more than three times after which the mill has to be scrapped finally. The final salvage value of

the mill is the same value of refurbished mill after 5 years of usage.

(vi) The production capacity after every refurbishment remains constant at

10,000 tonnes of SPO per annum.

(v) The extraction ratio of SPO is 12.5% of FFB input.

SCHEDULE 5


COST IMPLICATIONS OF A NEW MILL

Cost of purchase, including installation costs Estimated life N2.4 billion

Production capacity (SPO) p.a. 15 years

Production cost per tonne of SPO other than FFB: 24,000 tonnes


N

Material other than FFB 2,400

Labour 800

Fixed overhead of which depreciation comprise 40% 3,000

Selling price per tonne 65,000

Salvage value 25,000,00

Notes:

(i) The total estimated production of FFB is currently 72,000 tonnes annum. FFB that cannot be processed could be sold for N6,000 per tonne.

(ii) Production of FFB will increase every five years by 20% as a result maturity of new planting.

(iii) The extraction ratio of SPO is 20% of FFB input.

SCHEDULE 6


COST OF ACQUISITION AND OPERATION OF

PALM KERNEL CRUSHING PLANT

Useful life 10 years

N

Cost of acquisition including installation 15,000,000

Salvage value 1,500,000

One Engineer (salary p.a.) 360,000

One technical supervisor (salary p.a.) 180,000

Other fixed overheads p.a. (excluding depreciation) 1,350,000

VARIABLE COSTS OF PRODUCTION OF ONE TONNE OF PALM KERNEL

10 hours of grade 1 labour


20 hours of grade II labour

20 hours of grade III labour

Other variable costs N500

(i) Grades 1,11 and 111 labour are paid N25, N15 and N10 respectively per hour.

(ii) The expected production of FFB is 72,000 tonnes per annum. Uncracked kernel production is 75% of FFB input.

(iii) Extraction ratio of palm kernel is 50% of uncracked kernel.

(iv) One tonne of uncracked kernel can be sold for N2,500

(v) The plant is capable of processing all palm kernel produced.

(vi) Selling price per tonne of palm kernel is N7,000.

SCHEDULE 7


COST OF NEW PLANTING

Notes: N

Cost of initial land clearing per hectare 5,000

Cost of seedling per stand 180

Cost of planting per stand 70

Supervision cost per hectare p.a. 2,500

Plantation upkeep per hectare p.a 4,500

Cost of fertiliser per hectare p.a. 1,200

Notes:


(i) Number of palm trees per hectare 150 stands

(ii) The planting will be spread over three years. 500 hectares new planting will be done annually.

QUESTION 4.1

(a) Highlight some of the personnel problems farming Success Limited and make suggestions on what the company can do to revitalise the

management of the company.

(b) Community relationship is very important for land-based agricultural companies, what are the ways to improve the social relationship of the

QUESTION 2

(a) Using the financial statements in Appendices 1 and 2, you are required to compute the following ratios for Farming Success Limited for the

five years and comment on the trend.

(i) Earning Per Share

(ii) Quick ratio

(iii) Current ratio

(iv) Cost of production/turnover ratio. -

(b) The dividend payout ratio for the past five years had been 80% per annum. You are required to comment on this payout ratio having regard to

the current problems of the company .

QUESTION 4.3

(a) What is your advice to Farming Success Limited on the litigation instituted against it by Faith Palm Products Limited?


(b) What will be the implication on the pricing of the company's product B government introduced a special tax on SPO.

QUESTION 4.4

(a) Calculate the Net Present value of the refurbishment and replacement options* of the mill. Which option would you recommend? Assume the

cost of capital to be 15% and ignore inflation.

(b) There are two options to solve the immediate problem of spare parts procurement. You are required to advise on the more appropriate option.

Supporting your recommendation with necessary calculations. "

QUESTION 5

Compute the estimated full standard cost of a tonne of palm kernel in the first year of operation. A prospective customer had offered to pay N6.200

per tonne for the supply of 500 tonnes of palm kernel. Would you recommend the acceptance of this offer? The supply will not affect supplies to

other anticipated customers.

QUESTION 4.6

The company is desirous of planting 1.500 hectares in areas prone to local farmers' encroachment. You are required to prepare a three-year budget to

show the cost implication of the new planting, assuming 500 hectares will be planted every year.

QUESTION 4.7

(a) What are the ethical issues the company's external auditors should consider in its appointment as management consultant by the company?

(b) As the Management Consultant highlight the various ways of solving the problems of the company.

QUESTION 4.8

Extract the FFB production variances for the years 1989-2000 and comment briefly on possible causes of the variances.

case study exercises case 4 farming …starrygoldservices.com/icanknow16/icancsmaywk4qa.pdfcase 4...

Documents