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Belgrove Farms Inc.(Instructor's Note)

CASE DESCRIPTION

The primary subject matter of this case focuses on the calculation and use of comparative advantage in the allocation of resources within the firm. Secondary issues involve the use of accounting techniques and statistics to complete the business decision analysis of a profit opportunity. The case also presents strategic thinking and ethical issues related to business conduct in a family firm and the effects on consumers.

The case has a difficulty of level three, appropriate for junior level courses. The case is intended to be taught in three class hours, including a class presentation by student teams. The case is expected to require a minimum of three hours of outside preparation by student teams that present a report.

This case is designed for use in an upper-division, inter-disciplinary business course. The purpose of the course is to enable students to utilize the knowledge they have gained in their lower-division core business courses that include one economics course in microeconomics and two accounting courses (one course in financial accounting and one course in managerial accounting) and one statistics course.

Specifically, the case incorporates the understanding of comparative advantage, opportunity cost and how prices affect the allocation of resources, how cost data should be used in decision making, and the calculation of expected value.

CASE SYNOPSIS

Students are faced with a factual setting that presents practical business and ethical issues. The client, Belgrove Farms, is considering changing production from standard yellow corn to genetically modified corn. The farm has four sub-divisions that vary in production of the new product. Cost data is provided by an existing proposal. Future pricing of the genetically modified corn is uncertain. Using the concept of comparative advantage, the student must choose the appropriate allocation of production among the four sub-divisions, and calculate the anticipated change in profits. Students must also consider the nature of a family firm and any strategic or ethical issues associated with the proposed change in production.

INSTRUCTORS' NOTES

Recommendations for Teaching Approaches

This case is designed for use in an upper-division, inter-disciplinary business course. The purpose of the course is to enable students to utilize knowledge they have gained in the lower-division business core. In addition, the course aims to improve students' communication and teamwork skills. Student teams prepare the answers to questions presented in the case with coaching from faculty. The faculty coaching is intended to provide answers to team questions. All teams submit a formal written business report containing an analysis of the issues presented in the case. One team of students formally presents their case solution to the class. A second team of students acts as a "discussion team" by asking the presenting team for further explanation or clarification of their recommendations. Following the discussion team's exchange with the presenters, the entire class is welcome to participate in an active question and answer session.

Although the case is designed to be used in an upper-division, inter- disciplinary business course, the case can be easily modified for use as an in-class or take-home assignment in an introductory microeconomics course.

DISCUSSION QUESTIONS AND ANSWERS

General note: the firm is considering changing production to a new product, genetically modified (GM) yellow corn. The letter from Kevin Thorp (Exhibit 1) suggests a total switch in production from all AA yellow corn to all GM yellow corn. The production summary data (Exhibit 2) reveals differing relative capabilities of producing either AA yellow corn or GM yellow corn among the farm's four sub-divisions. One objective of the case is to help students understand that analyzing the sub-divisions as separate resources, and determining the profit- maximizing output from each sub-division can increase the farm's total profitability. Another objective of the case is to help students understand that the contribution margin (CM) for AA yellow corn per sub-division is the appropriate measure of the opportunity cost of producing GM yellow corn.

Q. 1. Belgrove Farms has four sub-divisions (four different farms it has previously acquired). Since the farms have different relative productive abilities (AA yellow corn vs. GM yellow corn), and production can be shifted by farm, consideration must be given to the best combination of outputs to maximize the economic profit.

a. Calculate the output of each farm for AA yellow corn or GM yellow corn. From this data, calculate the economic cost of AA yellow corn in terms of GM yellow corn (ratio) and the economic cost of GM yellow corn in terms of AA yellow corn (ratio)

[ i.e., 1 AA = ? GM; or 1GM = ? AA.]

Using the data from Exhibit 2, Table 1 shows the relative outputs of AA yellow corn or GM yellow corn for each farm. To calculate the physical opportunity cost for each farm, simplify the AA yellow corn to GM yellow corn ratios. For example, the Brookhurst Farm can produce either 20,000 bushels of AA yellow corn or 22,000 bushels of GM yellow corn. (Equation: 20,000 AA = 22,000 GM.) Dividing both sides of the equation by 20,000 results in 1 AA = 1.1 GM. Thus, the physical opportunity cost of each bushel of AA yellow corn is 1.1 bushels of GM yellow corn. Dividing both sides of the equation by 22,000 results in 1 GM = 0.91 AA. In this instance, the physical opportunity cost of each bushel of GM yellow corn is 0.91 bushels of AA yellow corn. The physical opportunity costs for each bushel of AA yellow corn and GM yellow corn for the remaining farms are determined in exactly the same manner.

b. Our marketing division has put together a projection of expected selling prices (see Exhibit 5). Apparently there are some consumer issues about the new corn. These issues may affect the expected selling price of GM yellow corn. Evaluation of some alternative prices for GM yellow corn may be in order.

The expected selling prices are stated in the price forecast portion of Exhibit 5.

AA yellow corn (domestic): $5.00/bushel GM yellow corn (domestic): either Scenario #1, $5.50/bushel or Scenario #2, $4.70/bushel.

c. Combine the relative output ratios from Q.1.a. with the selling prices from Q.1.b. to determine an optimal output table at each selling price of GM yellow corn. (Remember opportunity cost and comparative advantage analysis from economics, and contribution margin from accounting?)

The relevant comparison to make in deciding which crop to produce on each farm is to compare the contribution margin of a product with the opportunity cost. The contribution margin (CM) is the sale price of the product minus the expected production cost/bushel.

CM = Sale price per bushel--Expected production cost per bushel. The expected production cost (EPC) per bushel is stated in the cost analysis portion of Exhibit 1. The contribution margin describes how much each unit of output contributes to profit.

The opportunity cost of any choice is the forgone value of the next best alternative. If the production capacity of AA yellow corn on each farm were equivalent to the production capacity of GM yellow corn, the decision of which corn to produce is easy to make. If a farm can produce the same amount of corn, AA yellow corn or GM yellow corn, then the corn that produces the highest contribution margin will be the corn that will be produced on the farm. However, in light of Exhibit 2, it is evident that the production capabilities of AA yellow corn vs. GM yellow corn are not equivalent. The difference in production capabilities was the focus of the ratios that were determined in Question 1.a. Thus, in this case, the opportunity cost of growing AA yellow corn is the contribution margin of GM yellow corn times the number of bushels of GM yellow corn given-up for each bushel of AA yellow corn.

CM = sale price--EPC. AA yellow corn CM = $2.30 = ($5.00--$2.70) Scenario #1: GM yellow corn [CM.sub.1] = $2.25 = ($5.50--$3.25)

Scenario #2: GM yellow corn [CM.sub.2] = $1.45 = ($4.70--$3.25)

Determine output by comparing the dollar contribution margin with the dollar opportunity cost of production. This can be done for either column in Table 1: (1AA = ? GM or 1GM = ? AA).

For example, Brookhurst Farm under scenario # 1:

Consider planting AA yellow corn. For Brookhurst Farm, the opportunity cost of each bushel of AA yellow corn is $2.48 (1.1 GM yellow corn x $2.25). Planting AA yellow corn would not contribute the most to profit since the gain is $2.30/bushel and the opportunity cost is $2.48/bushel

Consider planting GM yellow corn. The GM yellow corn contribution margin is $2.25/bushel; the opportunity cost is $2.09/bushel (0.91 AA yellow corn x $2.30). Profit will be maximized by planting GM yellow corn on the Brookhurst Farm since the gain of $2.25 is greater than the opportunity cost of $2.09.

For further illustration, consider Gatos Peligo under scenario #1:

Consider planting AA yellow corn. For Gatos Peligo, the opportunity cost of each bushel of AA yellow corn is $3.38 (1.5 GM yellow corn x $2.25). Planting AA yellow corn would not contribute the most to profit since the gain is $2.30/bushel and the opportunity cost is $3.38/bushel.

Consider planting GM yellow corn. The GM yellow corn contribution margin is $2.25/bushel; the opportunity cost is $1.53/bushel (0.67 AA yellow corn x $2.30). Profit will be maximized by planting GM yellow corn on the Gatos Peligo farm since the gain of $2.25 is greater than the opportunity cost of $1.53.

Following similar reasoning for the remaining farms will produce results as seen in Tables 2 and 3 below.

Accounting Analysis of the Two Scenarios:

Students may alternatively calculate the total contribution margin from each farm and allocate production by picking the highest total CM per farm.

Scenario #1 analyzes how to use the farms if GM yellow corn sells for $5.50 per bushel. Scenario #2 analyzes how to use the farms if GM yellow corn sells for $4.70 per bushel.

Scenario #1: Compares total CM of AA yellow corn to CM of GM yellow corn at a selling price of $5.50 per bushel for GM yellow corn.

The accounting analysis confirms that if GM yellow corn sells for $5.50 per bushel, AA yellow corn would only be grown on the Fordum Estates farm; the remaining farms would grow GM yellow corn.

Scenario #2: Compares total CM of AA yellow corn to CM of GM yellow corn at a selling price of $4.70 per bushel for GM yellow corn.

This accounting analysis confirms that if GM yellow corn sells for $4.70 per bushel, then only Sally's Place should produce GM yellow corn.

Q. 2. Using the client's production cost data (Exhibit 1), demonstrate the change in profits expected from the above production recommendation for the alternative potential selling prices of GM yellow corn.

1. Sales: Multiply the total output of each product by the price.

A. AA:(290,000 x $5.00) = $1,450,000.

B. GM Scenario #1: (22,000 + 90,000 + 320,000) x $5.50 + 50,000 x $5.00 = $2,626,000.

C. GM Scenario #2: (20,000 + 50,000 + 60,000) x $5.00 + 320,000 x $4.70 = $2,154,000

2. Cost of production: Multiply the total output of each product by the per bushel cost.

A. AA: (290,000 x $2.70) = $783,000.

B. GM Scenario #1: (22,000 + 90,000 + 320,000) x $3.25 + 50,000 x $2.70 = $1,539,000.

C. GM Scenario #2: (20,000 + 50,000 + 60,000) x $2.70 + 320,000 x $3.25 = $1,391,000

Based upon the income from continuing operations before taxes as stated in Table 6, the production mix under scenario #1 will result in increasing profits by $420,000 ($668,095-$248,095). The production mix under scenario #2 will result in increasing profits by $96,000 ($344,095--$248,095).

Q. 3. Assuming the probabilities of alternative prices for GM yellow corn are as stated in Exhibit 5, calculate the expected change in profits from adopting our recommendation. (This is important since it can be used to justify our consulting fees.)

20xx expected profits: If there are alternative future scenarios, the expected profit is calculated as the sum of the probability of a scenario multiplied by the expected profits in that scenario.

In this case, the probabilities are 60% likely scenario #1 (GM yellow corn price = $5.50) and 40% likely scenario #2 (GM yellow corn price = $4.70). The expected profit is therefore: (0.60 x $668,095) + (0.40 x 344,095) = $538,495.

The percentage increase in expected profit is [($538,495--$248,095) / $248,095] = 117%

Q. 4. Okay, that's the economic analysis, but consider the nature of a family business and any strategic and ethical issues that might be important, and check with me. We want to make the right recommendation for the client.

This is an open-ended question. The instructor may invite the students to consider the nature of a family business, and the long run strategic and ethical implications of adopting the proposed new production of GM yellow corn.

Family business: A family business is subject to a number of unique potential problems. Family relationships may not translate easily into successful working relationships. Employment of family members may alter a successful management hierarchy. In this case, Kevin Thorp is a young business school graduate who is recommending a complete change of product. Robert Belgrove (his uncle) is the CEO with a more conservative viewpoint. Students may discuss the general problem in family businesses associated with the intergenerational differences in business philosophy and risk taking.

Strategic thinking: There are a number of ways to approach the issues of strategy that arise in the case. One approach is the Liedtka model. This model consists of five elements of strategic thinking--a system perspective; intent-focused; intelligent opportunism; thinking in time; and hypothesis-driven. The primary focus of strategic thinking is concerned with a creative and divergent thought process. Strategic thinking looks to the future. In this case, the students could analyze the five elements of strategic thinking in an attempt to develop strategies to deal with economic liabilities that may arise in the future.

Ethical considerations: Students may also evaluate the ethical issues related to the process of genetic modification. There are numerous approaches that are used to determine if one's actions are ethical. The most common of these approaches is the Stakeholder/Utilitarian Theory (maximize the net benefits to society as a whole, i.e., the greatest good to the greatest number). Other theories include the Rights Theory (respecting and protecting individual rights); Justice Theory (fair distribution of benefits and burdens); Categorical Imperative Theory (looking at the results if everyone acted in the same manner); and the Front Page Test (reaction if the decision is reported on the front page of the local newspaper). To answer this question, instructors must provide students with a framework wherein they can analyze Belgrove's decision from an ethical standpoint. Obviously the instructor will prefer that the ethical discussion include the approaches discussed in his or her course.

Changing to genetically modified products may also involve some additional risks for the firm. Students might mention:

1. Product liability risk: If the new product causes problems for the buyers, then the firm may face product liability lawsuits.

2. Brand name damage: Consumers may be unsure which product they are receiving if the firm produces any GM yellow corn. If there is concern about GM products or if real problems arise, the firm's brand name may be associated with the GM problems, leading to less demand for the firm's products.

3. Changing government regulations: Public concern may lead to changes in government regulations of the production and sale of the GM products. This may affect future costs or revenues.

4. Other costs may in fact change as two products, AA yellow corn and GM yellow corn, are produced. Two products create more complexity which may drive up administrative costs.

Richard Tontz, California State University, Northridge

Leonard Rymsza, California State University, Northridge

Leah Marcal, California State University, Northridge
Table 1. Physical Opportunity Costs

Farm              Acres    AA (1)     GM (1)    1AA = GM   1GM = AA
                          (1,000s)   (1,000s)

Brookhurst Farm    200       20         22        1.10       0.91
Fordum Estates     500       50        50.5       1.01       0.99
Gatos Peligo       300       60         90        1.50       0.67
Sally's Place      800      160        320        2.00       0.50
Total             1,800     290       482.5        --         --

(1) The relative outputs of AA yellow corn or GM yellow corn for each
farm are stated in Exhibit 2.

Table 2. Dollar Opportunity Costs Under Scenario # 1

Farm              Acres   AA (1,000s)   GM (1,000s)   1AA = GM x
                                                        $2.25

Brookhurst Farm    200        20            22#         $2.48
Fordum Estates     500        50#          50.5         $2.27
Gatos Peligos      300        60            90#         $3.38
Sally's Place      800        160          320#         $4.50
Total             1,800       50            432           --

Farm              1GM = AA x
                    $2.30

Brookhurst Farm     $2.09
Fordum Estates      $2.28
Gatos Peligos       $1.53
Sally's Place       $1.15
Total                 --

Note: The underlined numbers in Tables 2 and 3 indicate which product
should be produced on each farm is indicated with #.


The underlined numbers in Tables 2 and 3 indicate which product should be produced on each farm.
Table 3. Dollar Opportunity Costs Under Scenario # 2

Farm              Acres   AA (1,000s)   GM (1,000s)   1AA = GM x $1.45

Brookhurst Farm    200        20#           22             $ 1.60
Fordum Estates     500        50#          50.5            $ 1.46
Gatos Peligos      300        60#           90             $ 2.18
Sally's Place      800        160          320#            $ 2.90
Total             1,800       130           320

Farm              1GM =AA x $2.30

Brookhurst Farm       $ 2.09
Fordum Estates        $ 2.28
Gatos Peligos         $ 1.53
Sally's Place         $ 1.15
Total                   --

Notice at the lower price for GM yellow corn, only Sally's Place
should produce GM yellow corn.

Table 4a. Contribution Margins per bushel under Scenario #1 |

Selling price per bushel AA yellow corn          $5.00
Variable cost per bushel AA yellow corn           2.70
Contribution Margin per bushel AA yellow corn    $2.30
Selling price per bushel GM yellow corn           5.50
Variable cost per bushel GM yellow corn           3.25
Contribution Margin per bushel GM yellow corn    $2.25

Table 4b. Total Contribution Margins per farm under Scenario #1

Farm              Acres   AA yellow corn   GM yellow corn
                              prod.            prod.
                           @ $2.30/bsh       @$2.25/bsh

Brookhurst Farm    200        20,000           22,000
Fordum Estates     500        50,000           50,500
Gatos Peligo       300        60,000           90,000
Sally's Place      800       160,000          320,000
Belgrove Total    1,800      290,000          482,500

Farm                 Total CM       Total CM     Highest CM
                  AA yellow corn    GM yellow
                                      corn

Brookhurst Farm    $46,000 (1)     $49,500 (2)    $49,500
Fordum Estates       115,000         113,625      115,000
Gatos Peligo         138,000         202,500      202,500
Sally's Place        368,000         720,000      720,000
Belgrove Total       $667,000      $1,085,625    $1,087,000

(1) This amount is derived by multiplying the quantity of AA yellow
corn produced on Brookhurst Farm (20,000 bushels) by $2.30 (the
contribution margin per bushel of AA yellow corn).

(2) This amount is derived by multiplying the quantity of GM yellow
corn produced on Brookhurst Farm (22,000 bushels) by $2.25 (the
contribution margin per bushel of GM yellow corn).

Table 4c. Income Data under Scenario #1

                                             AA               GM

Sales and changes in value of crop     $1,450,000 (1)   $2,653,750 (2)
inventories

Cost of Production                      $783,000 (4)    $1,568,125 (5)

Selling, General, and Administrative      $313,200         $313,200
Expenses (7)

Technological Expenses (7)                $93,960          $93,960

Other (7)                                 $11,745          $11,745

Income from continuing operations         $248,095         $666,720
before taxes

                                         Highest CM

Sales and changes in value of crop     $2,626,000 (3)
inventories

Cost of Production                     $1,539,000 (6)

Selling, General, and Administrative      $313,200
Expenses (7)

Technological Expenses (7)                $93,960

Other (7)                                 $11,745

Income from continuing operations         $668,095
before taxes

(1) Based upon production of 290,000 bushels of AA yellow corn at a
sales price of $5.00/bushel.

(2) Based upon production of 482,500 bushels of GM yellow corn at a
sales price of $5.50/bushel.

(3) Based upon dollar opportunity costs in Table 2, with Fordham
Estates producing 50,000 bushels of AA yellow corn at a sales price of
$5.00/bushel ($250,000) and the remaining farms producing 432,000
bushels of GM yellow corn at a sales price of $5.50/bushel
($2,376,000).

(4) Based upon production of 290,000 bushels of AA yellow corn at a
variable cost of $2.70/bushel.

(5) Based upon production of 482,500 bushels of GM yellow corn at a
variable cost of $3.25/bushel.

(6) Based upon Fordham Estates producing 50,000 bushels of AA yellow
corn at a variable cost of $2.70/bushel ($135,000) and the remaining
farms producing 432,000 bushels of GM yellow corn at a variable cost
of $3.25/bushel ($1,404,000).

(7) Based upon first prior year expenses listed in Exhibit 3.

Table 5a. Contribution Margins per bushel under Scenario #2

Selling price per bushel AA corn          $5.00
Variable cost per bushel AA corn           2.70
Contribution margin per bushel AA corn    $2.30
Selling price per bushel GM corn           4.70
Variable cost per bushel GM corn           3.25
Contribution margin per bushel GM corn    $1.45

Table 5b. Total Contribution Margins per farm under Scenario #2

Farm              Acres   AA yellow corn   GM yellow corn
                              prod.            prod.
                            @$2.30/bsh       @$1.45/bsh

Brookhurst Farm    200        20,000           22,000
Fordum Estates     500        50,000           50,500
Gatos Peligo       300        60,000           90,000
Sally's Place      800       160,000          320,000
Belgrove Total    1,800      290,000          482,500

Farm               Total CM      Total CM     Highest CM
                   AA yellow     GM yellow
                     corn          corn

Brookhurst Farm   $46,000 (1)   $31,900 (2)    $46,000
Fordum Estates      115,000       73,225       115,000
Gatos Peligo        138,000       130,500      138,000
Sally's Place       368,000       464,000      464,000
Belgrove Total     $667,000      $699,625      $763,000

(1) This amount is derived by multiplying the quantity of AA yellow
corn produced on Brookhurst Farm (20,000 bushels) by $2.30 (the
contribution margin per bushel of AA yellow corn).

(2) This amount is derived by multiplying the quantity of GM yellow
corn produced on Brookhurst Farm (22,000 bushels) by $1.45 (the
contribution margin per bushel of GM yellow corn).

Table 5c. Income Data under Scenario #2

                                             AA               GM

Sales and changes in value of crop     $1,450,000 (1)   $2,267,750 (2)
inventories

Cost of Production                      $783,000 (4)    $1,568,125 (5)

Selling, General, and Administrative      $313,200         $313,200
Expenses (7)

Technological Expenses (7)                $93,960          $93,960

Other (7)                                 $11,745          $11,745

Income from continuing operations         $248,095         $280,720
before taxes

                                         Highest CM

Sales and changes in value of crop     $2,154,000 (3)
inventories

Cost of Production                     $1,391,000 (6)

Selling, General, and Administrative      $313,200
Expenses (7)

Technological Expenses (7)                $93,960

Other (7)                                 $11,745

Income from continuing operations         $344,095
before taxes

(1) Based upon production of 290,000 bushels of AA yellow corn at a
sales price of $5.00/bushel.

(2) Based upon production of 482,500 bushels of GM yellow corn at a
sales price of $4.70/bushel.

(3) Based upon dollar opportunity costs in Table 3, with Sally's Place
producing 320,000 bushels of GM yellow corn at a sales price of
$4.70/bushel ($1,504,000) and the remaining farms producing 130,000
bushels of AA yellow corn at a sales price of $5.00/bushel ($650,000).

(4) Based upon production of 290,000 bushels of AA yellow corn at a
variable cost of $2.70/bushel.

(5) Based upon production of 482,500 bushels of GM yellow corn at a
variable cost of $3.25/bushel.

6 Based upon Sally's Place producing 320,000 bushels of GM yellow corn
at a variable cost of $3.25/bushel ($1,040,000) and the remaining
farms producing 130,000 bushels of AA yellow corn at a variable cost
of $2.70/bushel ($351,000).

(7) Based upon first prior year expenses listed in Exhibit 3.

Table 6. Alternative Production Choices for 20XX

                                        AA Yellow    GM Scenario #1

Sales and changes in value of crop      $1,450,000     $2,626,000
inventories

Cost of production                       $783,000      $1,539,000

Selling, General, and Administrative     313,200        313,200
Expenses

Technological Expenses                    93,960         93,960

Other                                     11,745         11,745

Income from continuing operations        $248,095       $668,095
before taxes

                                        GM Scenario #2

Sales and changes in value of crop        $2,154,000
inventories

Cost of production                        $1,391,000

Selling, General, and Administrative       313,200
Expenses

Technological Expenses                      93,960

Other                                       11,745

Income from continuing operations          $344,095
before taxes
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Title Annotation:Instructor's Note
Author:Tontz, Richard; Rymsza, Leonard; Marcal, Leah
Publication:Journal of the International Academy for Case Studies
Article Type:Case study
Geographic Code:1USA
Date:Dec 1, 2009
Words:4221
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