The value chain and strategic cost analysis. Clarion Products raises trees, cuts
ID: 2655306 • Letter: T
Question
The value chain and strategic cost analysis.
Clarion Products raises trees, cuts the trees into logs, and processes the logs into paper. Clarion Products sells the paper to a distributor, who then sells the paper to printers.
Assume that a weighted-average cost of capital of 10 percent is appropriate for timber and paper processing. Here are the costs and revenues of each stage of the value chain. All data are for the production of enough timber to produce 20,000 tons of paper.
Timber. The estimated market value of timber assets at the beginning of the year is $5,100,000 and at the end of the year is $4,800,000. Revenues, if the timber were sold in the market, would equal $2,100,000. Operating costs total $1,500,000, excluding depreciation.
Paper Processing. The estimated market value of paper-processing assets at the beginning of the year is $15,000,000 and at the end of the year is $13,000,000. Revenues, if the paper were sold in the market, would be $12,000,000. Operating costs total $9,000,000, including all costs of materials but excluding depreciation.
Distributor. The distributor sells the paper for $800 per ton. The cost of the paper to the distributor (cost of goods sold) can be found by reviewing the sales from paper processing. In addition to the cost of paper, the operating costs total $135 per ton, excluding economic depreciation. The cost of capital for the distributor is $50 per ton.
Retailer. The retailer sells the paper for $850 per ton. The cost of the paper to the retailer (costs of goods sold) can be found by reviewing the sales from the distributor. Operating costs total $25 per ton, including economic depression. The cost of capital for the retailer is $18 per ton.
a. Compute the profits of each stage of the value chain. Show amounts in total (for $20,000 tons) and per ton.
b. Assume you are advising a loan approval committee in a bank. Write a short memo to the loan approval committee in which you evaluate the profitability of each part of the value chain.
Explanation / Answer
Value chain is a technique where a product or service is divided into different activities. At each stage some value is created. This technique wil estimate how much profit is contributed by each stage of activities.
In the problem you are dealing with paper production. The entire process starts with planatation of trees. Then trees are cut into timber. These timbers ae inputs in paper industry. Here paper s manufactured . Then manufactured paper is transferred to distributors. In the last stage distributor sells it to printers. Profit at each stage of value chain has been computed below.
Stage 1: It is the manufacturing of timber. Initially trees are planted. Then it is cut to timber. The profit at this value chain is calculated below:
Thus profit contributed by timber activity in the total chain of manufacturing and selling of 20,000 tons of paper is $300,000. Thus profit per ton is $300,000 / 20,000 = $15
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Second activity in value chain is manufacturing of paper. Here timber sold by perevious activity is used as input or raw material. With this other operating costs are added. Thus total total operating cost excluding depreciartion but including raw material is $9,000,000. With this add depreciation cost of paper processing asset. It is the difference between value of paper processing asset at the begining and at the end of the year. Add the two to get total cost of manufaturing 20,000 tons of paper. Deduct it from the total market value to get the profit of this value chain stage. It is shown in the table below:
answer: Above table indicates that total profit of maufacturing paper stage is $1,000,000. Profit per ton is $50.
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Third stage is selling of paper to distributors. First you should consider cost of paper. It is the sale value of previous activity. It is $11,000,000 for 20,000 tons. Thus cost per ton is $11,000,000 /20,000 = $550. With this add operating cost per ton of $135 and cost of capital $50 per ton to get total cosdt. Deduct it from distributors sale price to get profit contributed distributor. It is shown below:
Answer: Profit per ton contributed by distributor is $65. So total profit of distributor is $65 x 20,000 tons = $1,300,000
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Last stage is sale of paper by retailer to proniters. Here printeres are its ultimate consumer. Here also consider sale pricve of distributors. It is cost of retailer. Add operating cost.and cost of capital to retailer. Now you will get total cost of product passed on to printer. Deduct this cost from sale price to get profit.
Answer: Thus retailer is contributing $7 profit per ton. Total profot is $7 x 20,000 tons = $140,000
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Answer of part (a)
Considering all tables and analysis a summarized profit of each stage of value chain has benn shown in the table below
Profitability at each stage of value chain
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Answer of part (b):
Now you have to draw a memo advising a loan approval committee to evaluate profitability. It will depend upon WACC rate of 10% for timber and paper processing.
MEMO
Subject: Value chain analysis of paper manufacturing and their sale to printer.
An effort has been made to make a value chain analysis of paper manufacturing and their sale to printers. It has been undertaken in four stages. They are:
1. Timber manufacturing stage.
2. Paper processing stage
3. Distributors stage and
4. Retailers stage
Results are shown below:
1. Timber Stage: At this stage value of timber at the begining of the year was $5100,000. Value at end was $4,800,000. These figures are indicating initial investment in timber stage. Average investment of the year is:
($5,100,000 + $4,800,000) / 2= $4,950,000. A 10% is WACC, this staze is expected to contribue 10% of $4,950,000 i.e. $495,000. But actual contribution is only $300,000. Thus this stage is not capable of satisfying investors minimum requred return. If the project is stopped at this stage, then bank should not give loan to the concern.
2. Second stage is paper manufacturing. Here begining value of paper procesing asset is $15,000,000 and ending value is $13,000,000. So average annual investment is ($15,000,000+$13,000,000)/2= $14,000,000. as WACC is 10%, the paper manufacturing stage is expected to contribute a minimum profit of $14,000,000 x 10% =$1,400,000. This stage is contributing only $1,000,000. Thus minimum required return is not earned. Hence bank should not sanction loan if the activity is stopped at this stage.
3. Third stage is distributor stage. Her proft contribtion per ton is $65. This figure has been arrived at after deducting capital cost of $50 for this stage. Thus it is capable of contributing $65 more than its minimum required cost of capital. So bank must provide loan at this stage. This surplus money of $65 will eliminate defecit of previous two stage. Total deficit of previous two stage was $195,000+$400,000=$595,000. Here the firm is getting value addition of $65 x 20,000 = $1,300,000. So even after covering the previous deficits a postive value addition has been made.
4. Last stage is retailer stage. It also making a value addition of $7 per ton after recovering cost of capital of $18 for this stage. Thus it is also adding some value to the bank.
Hence loan approval commitee is advised to approve loan upto the last stage of he entire value chain. If firm has decided to stop actibvities at timber or paper stage then loan approval will not be advisable.
Amount Amount 1. Market value of timber asset at the begining of the year $5,100,000 2. Market value of timber at the end of the year $4,800,000 3. Depreciation of timber asset [ 1 - 2] $300,000 4. operating cost $1,500,000 5. Total cost [ 3+4] $1,800,000 6. Market value of timber sold $2,100,000 7. Profit contributed by timber [ 6 - 5] $300,000Related Questions
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