Mercer Farms Case Student Coaching Notes

Top Ten LDC Concepts in Case Micro: #1: Opportunity cost Micro: #2: Comparative advantage Micro: #4: How prices affect resource allocation. Management Accounting: #8. How to use cost data in decision-making. What is relevant? Statistics: # 5. The concept of expected value and how to calculate it

Case Facts – Key Players Mercer Farms – Client Allen Mercer – CEO Michael Bell – Operations Manager Karen Lee Team Leader You have been hired by Karen’s team

Case Facts – Overview Mercer Farms owns four different fields and grows AA Corn Michael Bell wants Mercer Farms to switch to GM Corn His profit analysis is contained in Exhibit 1 Is based on a price of $3.25 for GM corn Assumes entire acreage is devoted to either AA or GM corn Ignores price uncertainty of GM corn Productivity differs across farms (See Exhibit 2) Mercer’s income statements are available (See Exhibit 3) Forecasted price for GM corn (See Exhibit 4)

Case Facts: Price Data AA Corn is expected to sell for $ 5.00/bushel GM Corn has two possible prices. GM Corn: $ 5.50/bushel GM Corn: $ 4.70/bushel

What type of corn to plant in which field? Case Facts – Key Issue What type of corn to plant in which field? How to deal with the uncertainty around GM corn’s prices? What is differential profit from the recommended growing strategy?

When Does Mercer Know Prices? Assumption: Prices revealed before planting decision Today Analysis being done Actual Outcome Prices of GM corn known Action Date Planting decision made

Mercer Farms is a Price Taker Firm (Most Competitive Market) Mercer Farms is one of thousands of firms producing the same product. As such, they have no market power to set price, but take the price from the market. The market price is determined by the interaction of all the buyers (demand) and sellers (supply) of yellow corn.

Economic & Accounting Concepts of Profit Business firms attempt to maximize economic profit. ()  = Total Revenue – Total Economic Cost Total Revenue = Price x Quantity Total Economic Cost = the Opportunity Cost of the resources used in production Accounting Profit = Total Revenue – Total Variable and Fixed Costs Incurred Cost is the actual amounts paid or obligations entered into for future payments

Comparative Advantage A resource (farm) has a comparative advantage in the production of a good (GM corn) if it has the lowest opportunity cost of production The four farms have differing relative abilities to produce AA or GM corn The production decision should compare each farm’s gain (contribution margin) with the opportunity cost of production

Opportunity Cost of Production The opportunity cost of any output is the value of the best alternative given up The economic (opportunity) cost of producing GM corn depends on the amount of AA corn given up and the contribution margin from producing AA corn

Cost Classifications Variable costs -- those that change with change in activity levels (e.g., units produced, service provided) in an organization Fixed costs -- those that do not vary with the activity level Incremental costs - the change in costs associated with changing the output above some base level or selecting one course of action over another Relevant costs - those costs that differ across alternative courses of action Opportunity costs - the benefit foregone by not using a limited resource in its best alternative use