CASE STUDY - Goats: The Green Alternative A

QUESTIONS:

Clearly indicate the answer to each of the questions and show how you arrived at your answer:

1. What incremental revenues will McCoy receive if he accepts the proposal?

2. What incremental costs will McCoy incur if he accepts the proposal?

3. Using number of days as the cost driver, prepare a table that describes the costs

identified as either fixed or variable and if variable, the rate/day.

4. Compute the contribution margin per day for the current proposal.

5. Compute the numbers of days needed for McCoy to breakeven for the current

proposal.

6. If you were McCoy, would you go ahead with the current proposal? Why or why not?

What other factors would you consider beyond those calculated in questions 1 to 5?

Richard Ivey School of Business IV I E The University of Western Dntarlo 93113613 GOATS: THE GREEN ALTERNATIVE (A) David M. Currie and Kyle S. Meyer wrote this case solely to provide material for class cscussion. The authors do not intend to illustrate either e'ective or ine'eotiue handling of a managerial situation. The authors may have disguised certain names and other identifying infoonation to protect confidentiality. Renard hey School of Business Foundation prohibits any form of reproduction, storage or transmission without its written pennisaion. Reproduction or this material is not covered under audiorizaiion by any reproduction rights organization. To order copies or request pennission to reproduce materials, oorrteot lvey Publishing. Richard trey School of Business Foundation, The University of Western Ontario, London, Ontario, Canada, Nail 3K7; phone (519) 66113208; fax (519) 661-3882; email cases@ivey.uwo.ca. Copyright c: 2011, Richard lirey School of Business Foundation |lielrsion: 2011-1 1-17 laden McCoy operated a dairy goat farm in Soddy-Daisy, Tennessee. In January 2011, the owner of a nearby resort approached McCoy about using goats to clear a section of his property. The property had become overgrown with a variety of weeds, and was situated on a steep hillside that made it difcult for the maintenance staff to reach with power machinery. This particular site was populated with nettles, kudzu and poison ivy, all of which are safe for goats. There was no evidence of plants such as azalea or Oleander that are toxic for goats. McCoy knew goats had become popular for property maintenance in situations where the terrain was rocky or uneven. He had been approached by other property owners about renting out his herd, but had rejected the offers because he was not able to determine the overall cost. To consider this offer, McCoy assembled information to determine whether such an undertaking was protable. The next step was to put this information into a format that would help him decide whether he should accept the proposal. MCCOY'S DAIRY GOAT BUSINESS In the United States, the dairy goat business is fragmented and localized. According to the us. - Department of Agriculture's 2007 Census of Agriculture, there were 27,481 fauna containing 334,754 goats, meaning each farm averaged 12 ,c__r,oats.1 Eighty per cent of the goat farms had fewer than 100 head. There was not much demand for goat's milk from the general population, particularly when compared to cow's milk. Goat's milk was usually sold to local customers, frequently as feed for other animals due to its high nutritional content.2 McCoy's dairy goat farm was one of 50 within a radius of 100 miles, including eastern Tennessee, western North Carolina, and northern Georgia. McCoy thought his farm of 100 does was the largest in the region. Page2 ' I 93113018 W McCoy had many other business interests outside dairy goat farming; dairy goats represented a small part of the total. They kept his 60 acres free of noxious weeds, did not require an inordinate amount of attention, and created a small prot. McCoy acquired goats many years ago almost by accident. He attended the Hamilton County Livestock Exposition with a girlfriend who thought the goats were \"cute\" when she saw them on exhibit. She purchased four of them " a buck and three does as a present. The present lasted longer than the ' girlfriend did, and through the years the herd grew to its present size of 100 does and one buck. The does produced milk that McCoy sold to a local health food cooperative. Multiple births are common for does. The period during which a doe lactates lasts up to 300 days. In the latter part of the gestational period, the doe is dry and produces no milk. Some of McCoy's does were unproductive because they did not become pregnant or produced little milk, so McCoy culled them from the herd along with the excess kids to maintain a herd of 100. All the adult males except two were sold because there was no reason to have males in a dairy herd, except to impregnate the females. The primary source of revenue from the goats was milk sales, but other revenue was derived from the sale of culled does and kids. The traditional method of allocating expenses in most animal-raising enterprises is on a per-head basis, so costs in the dairy farm were allocated per doe. The primary cost was feed, including forage, grain and minerals, but also milk for replacement livestock. Wages for day labourers were another major expense. These employees helped McCoy tend the goats, milk them and deliver the milk to the cooperative. McCoy had to purchase replacement livestock each year to bring new blood lines into the herd, adding vigor and improved milk production. It also was necessary to replace livestock lost due to age, predation and disease. This shrinkage could amount to as much as 2530 per cent of the herd each year. A replacement doc cost US$200-300, while a buck cost US$400500. Net revenue after variable costs the contribution margin had to cover the xed costs of operating the farm: depreciation of the milking equipment and other machinery, the barn and purchasing replacement livestock. The most recent income statement revealed the farm generated taxable income of US$3,291 in 2010 (see Exhibit 1). This amount was added to other income McCoy earned so he could calculate his tax liability for the year. THE PROPOSAL The potential client was a resort of several hundred acres in the foothills of the Smoky Mountains between Chattanooga and Knoxville, Tennessee. Due to the rocky terrain, the grounds keeping staff found it difficult to maintain portions of the property. Workers frequently had to cut and trim by hand rather than by machine, increasing the cost of property maintenance. Consequently, the maintenance supervisor called laden McCoy one afternoon to inquire about using goats in place of maintenance staff on the portions of the property where machinery could not be used. The supervisor invited McCoy to suggest a price. McCoy believed he was the only person bidding on the contract at this time. Page 3 REVENUES Revenue from this project would come from renting the goats. Mccoy did not have experience renting out goats, but he believed he could earn a profit at a rental fee per day of US$ 15. Since he was the only bidder, Mccoy realized he could raise the fee if his calculations revealed that the project would be unprofitable. Mccoy had to determine how many goats were necessary and how long they would be on site. Since the trailer held up to 25 goats, Mccoy decided he would transport the maximum number of goats to the job, pricing each job on the basis of 25 goats per day. The number of calendar days on a job would vary according to the size of the site. Mccoy had to determine how much the goats would eat to adequately estimate the time for this project. The amount of forage goats would eat actually depended on the density and type of vegetation. A goat in a pasture would eat about 250 square feet of forage daily, but Mccoy had no idea how much they could eat on a wild hillside. He decided to use 250 square feet as the numerical amount in his calculations, declaring it the forage square feet per goat. In his formula, the site area, the number of goats and the forage square feet per goat determined the number of calendar days the goats would spend on site. At 360 feet by 121 feet, the proposed property was an acre in size. Once he determined the number of calendar days spent on site, Mccoy could calculate revenue from the proposed project as a function of the number of goats, the rental fee per day and the number of calendar days. Due to difficulties loading and unloading the goats, Mccoy decided to bill for a full day even when the job required only a portion of a day. If a job took three and a half days to complete, the client would be billed for four full days. EXPENSES Mccoy identified four categories of expenses for the project: set-up costs, fencing costs, shepherd and dog costs, and transportation costs. Set-up Mccoy realized he would incur some costs prior to transporting the goats to the job site. Goats require a covered area (goats do not like to get wet), water, a mineral lick and other supplies while grazing. When the job was complete, these facilities would need to be removed and transported back to Mccoy's farm. Mccoy estimated these costs, which he called set-up costs, at approximately US$100. Fencing Goats tend to disperse when foraging, so it is difficult to keep them in one location. Enclosing the site served two purposes: it kept the goats within a confined area and provided some protection against predators, including bobcats, coyotes, bears and even domestic dogs. Mccoy investigated various fences and discovered he could obtain vinyl fence for US$0.75 per linear foot, fully installed. The fence would be installed around the perimeter of the site, so fencing costs depended on site perimeter and fencing cost per linear foot. The vinyl fence was not reusable; Mccoy would deliver it to a local recycle center when the job was complete.Page 4 - 93113013 W Shepherd and Dog A shepherd would transport the goats to and from the site. With. the aid of a dog, the shepherd would also tend to the goats on site. McCoy determined 10 hours of compensation would cover the shepherd's time, including driving and tending to the goats. He found a local farmhand to take care of the goats on an as- needed basis. The fannhand was willing to accept US$190 per day to tend the goats. Shepherd and dog costs were determined by the number of calendar days and shepherd and dog rate per calendar day, xed at US$190. Transportation McCoy already had a trailer that he could use for transporting goats, but using it more intensively would lead to increased maintenance on the trailer. Transporting the goats to the site and back would also require a truck with its own fuel and increased maintenance costs. McCoy believed US$0.63 per mile sufcient to cover the fuel cost and increased maintenance for both vehicles. McCoy would limit his transportation costs by making only one round trip each day with a fully loaded trailer of 25 goats. The proposed site was 40 miles from McCoy's farm in Soddy-Daisy, and would require two trips one to the site and one return each day. Overall, there were four aspects of transportation costs: rate per mile and miles to site, trips per day (limited to two) and number ofcalendar days. ANALYZING THE DECISION McCoy was reasonably certain if his goats performed satisfactorily on this project, the property owner would invite him to clear other portions of the property. Other property owners might learn of the success and invite McCoy to bid on clearing their properties as well. McCoy believed this could add signicant value to his business, representing an important prot opportunity. McCoy did not want to limit his perspective to only this project. He decided to build a model to change any of the inputs, such as site dimensions, cost of fencing and miles to the site. The model could help him determine the protability of each project based on the estimated total revenues, total variable costs and total fixed costs. With all of these thoughts, McCoy sat down at the table with paper, pencil and a computer with a blank spreadsheet open before him. He was ready to formulate the model to tell him whether he could make a prot on this project; one he could use to price future projects. McCoy needed to classify costs as either xed or variable and incorporate these cost behaviors into his model. He realized a number of factors affected total costs, but he hoped the model could identify these factors. Page 5 98118018 Exhibit 1 INCOME STATEMENT, 2010 per herd of per doe 100 does Revenues Milk sales 545.60 54,560.00 Other revenues 49.06 4,906.00 Total revenues 594.66 59,466.00 Variable costs Forage 99.00 9,900.00 Grain mixture 126.23 12,622.50 Milk for replacements 49.50 4,950.00 Supplies 13.20 1,320.00 Veterinary fees / medicine 24.20 2,420.00 Bedding 11.55 1, 155.00 Fuel 5.48 547.80 Utilities 15.40 1,540.00 Repairs & other costs 11.00 1, 100.00 Labor 148.50 14.850.00 Total direct costs 504.05 50,405.30 Contribution margin 90.61 9,060.70 Fixed costs Milking equipment depreciation 1,980.00 Housing barn depreciation 594.00 Machinery depreciation 357.50 Replacement livestock 2.838.00 5,769.50 Taxable income 3,291.20