Farmers sometimes store their grain and wait to sell at a later date if they thi
ID: 2773496 • Letter: F
Question
Farmers sometimes store their grain and wait to sell at a later date if they think market prices will increase. If they are accurate in their forecasts, this can be a profitable strategy. Let’s look at an example and determine the best course of action for Farmer Jones. Farmer Jones just harvested 80,000 bushels of wheat that he currently has in grain bins on his farm. He considered selling this year’s harvest but the current market price is only $6.50 a bushel. He strongly believes that in one year from now, wheat prices will be at least $8.00 a bushel.
Your original discussion post should include:
Assuming a 5% interest cost, what should Farmer Jones do with this year’s harvest?
What happens if Farmer Jones has 10% of his wheat spoil while in storage?
What other factors would be important to consider when making this important decision?
Explanation / Answer
Farmer Jones should store all the grains and would sell it later after an year as after an year he would get total returns (80000*8)= $640000. If 5% is the interest Cost, PV discounted at 5% i.e. 640000/1.05= $609524, which is again more than Current selling price which is (80000*6.5)=$520000. So there is total gain of (609524-520000)= $89524 (as per current scenario).
If, 10% of wheat spoils due to storage, then also Jones should go for selling the same after 1 year from now. Because after 1 year Jones will get the return (80000-10%*8) = $576000. If 5% is the interest Cost, PV discounted at 5% i.e. 576000/1.05= $548571, which is again more than Current selling price which is (80000*6.5)=$520000. So there is total gain of (548571-520000)= $28572 (as per current scenario).
While taking the decision of storing the wheat for one year and selling the same after one year, some other factors rather than interest cost should also be taken care of, like :-
(a) Storage Cost of Inventory
(b) Carrying Cost of Inventory
(c) Ordering cost by the next year.
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