Introduction
Superior Grain Elevator was situated in Thunder Bay, Ontario, which is known as Canada’s third busiest port. This facility consisted of 14 enormous grain elevators that allowed for the continuous loading of ships, thus facilitating the shipment of grain to Eastern Canada and other destinations worldwide. The process involved agents who organized the necessary shipping capacity to meet the requirements set by Superior’s different contracts.
Despite the agents’ efforts to coordinate ship arrivals at Thunder Bay, the unpredictable transfer times of lockage in the Seaway led to a wide range of arrival times. This occasionally caused arriving ships to wait at anchor if both wharfs were occupied. As a result, SGE had to pay demurrage charges of $2000 per day. Mike Armstrong, the manager of port facilities for SGE, recently discovered that the Canadian Government had made a 5-year contract with Poland, and some of the shipments would be allocated to Superior.
However, Superior Grain Elevator is currently facing a potential issue with its two existing wharfs. It is considered that these two wharfs may not be sufficient to efficiently fulfill the contract. To address this concern, the company is contemplating constructing a third wharf, which is predicted to incur a cost of $1,500,000. In order to decide whether the advantages and cost savings will justify the investment, Superior Grain Elevator must carefully evaluate and weigh the pros and cons of building the third wharf. After thorough analysis using formulas such as ROI, NPV, FV, as well as @Risk, it is our recommendation that Superior Grain Elevator refrains from proceeding with the construction of a third wharf.
Despite the third wharf generating savings of $230,115 per season or $1,150,575 over five years, these financial benefits do not compensate for the total construction cost of the new wharf, which amounts to $1,500,000.
BACKGROUND
Superior Grain Elevator had a significant presence on the Thunder Bay waterfront in Ontario, Canada, thanks to its 14 massive grain elevators. Being located in Thunder Bay, Canada’s third busiest port, made it crucial for the transportation of grain. Superior’s activities primarily revolved around the railroads and the Seaway.
Trains transported the grain to Thunder Bay where it was stored in lakefront elevators. The grain was then loaded onto freighters. During the four winter months, when the Seaway was frozen, Superior constantly loaded ships with grain and shipped it to Eastern Canada and other parts of the world. The ships were contracted by agents who arranged for the necessary shipping capacity to fulfill Superior’s contracts.
Despite the agents’ efforts to schedule a consistent flow of ships to arrive at Thunder Bay, the unpredictable transfer times in the Seaway resulted in a wide variety of arrival times. If both of Superior’s wharfs were occupied, incoming ships had to wait in the lake and Superior had to pay a demurrage charge of $2000 per day. Recently, Mike Armstrong, SGE’s manager of port facilities, discovered that the Canadian Government had made a five-year agreement with Poland for an 8 million tonne grain deal. As part of this contract, Superior was granted 20 shipments to Poland each year for five years. This new contract could be the long-awaited opportunity for SGE to consider constructing a third wharf.
Superior has been contemplating the addition of a third wharf for a while. The contract with Poland provides an opportunity to make it a lucrative choice. The cost estimation for the construction of the third wharf is $1,500,000, and it necessitates a 20% return on investment. Superior Grain Elevator needs to assess the pros and cons of building a third wharf and ascertain if the benefits and savings surpass the cost of investment.
CASE QUESTIONS
- How much can they save if the third wharf is build? If Superior Grain Elevator Inc. decides to build the third wharf, the company will save $224,481 per season in demurrage charges.
- Will construction of the third wharf reduce ship waiting time sufficiently for the savings in demurrage to “pay for” the new wharf? Discuss ROI, NPV and FV (please use excel functions) Even though the construction of the third wharf will provide the company a mean of savings of $230,115 per season, or $1,150,575 in five years, it does not offset the cost of building the new wharf ($1,500,000). When calculating the rate of return of the investment by using the subtraction between the gain and the cost of the investment divided by the cost of the investment, it gave us a negative rate of return on the investment of -23. 29%. In addition, we analyzed the Net Present Value and Future Value of the investment. To calculate NPV we considered the gain per season ($230,115) as cash flow, plus 20% expected rate of return and the initial capital investment of ($1,500,000) to conclude a negative value of $676,511. 34. The FV was calculated using the 20% expected rate of return, during a period of 5 years, considering $230,115 as savings each season with a present value of the investment of $1,500,000 resulting in a negative value of $5,787,393. With the analysis of these financial metrics it has been concluded that the savings in demurrage will not be sufficient to pay for the new wharf.
- What is the capacity and utilization of the wharfs? The maximum capacity of 2 wharfs is 115 ships per season, if a third wharf is built the capacity increases to 192. With two wharfs the company does not have the Capacity to serve all the expected ships coming as a result of the Polish contract. By dividing the number of ships arriving during one season by the capacity of the two wharfs (135/115 = 117%) they have a 17% over capacity. If the third wharf is added the capacity utilization will be 70% calculated by diving the number of expected ships (135) by the capacity of the three wharfs (192). After the Polish contract is over the Capacity utilization, assuming the third wharf is built will be reduced to 60% (135-20/192).
- Do you recommend building the third wharf? After carefully reviewing all financial metrics used to analyze this case, we concluded that Superior Grain elevator should not build a third wharf. According to the simulation analysis the cost of the initial investment will not be offset by the savings it will produce. The table below shows us the mean of savings per season of $230,115 and $1,150,575 extended to five seasons, these numbers clearly demonstrate that the savings perceived by building a third wharf will not be sufficient to cover the investment cost.
ANALYSIS
After conducting our simulation, financial and capacity analysis, we have concluded that constructing the third wharf would not yield enough savings to justify the investment cost. We utilized At Risk to perform the simulation analysis and assess the average, maximum, minimum, and standard deviations of the savings.
The third wharf is projected to save an estimated average of $230,115.58 per season in demurrage costs. However, multiplying this average by 5 seasons would only give a total savings of $1,150,575, which is less than the investment cost of $1.5 million. The standard deviation of $138,898.35 shows the potential range of outcomes, with the best-case scenario being $369,013.4 and the worst-case scenario being $91,217.23.
In addition to these findings, we also took into account other financial metrics such as Net Present Value (NPV), Future Value, and Return on Investment (ROI). Assuming an expected rate of return of 20% and using the mean savings as cash flow over five years with an initial investment of $1.5 million , we calculated a negative NPV of -$676,511.4.
The future value resulted in -$5,787,393. The ROI was calculated by subtracting the savings from the investment cost over five seasons and then dividing that by the investment cost, resulting in -23.29%. To assess the potential improvement in efficiency, we examined the capacity and utilization of the wharfs. Prior to the Polish contract, Superior Grain Elevator operated at 100% capacity with two wharfs. With the inclusion of the 20 ships from the Polish contract, maintaining two wharfs would result in a capacity of 117%.
However, constructing the third wharf would result in a utilization of only 70% capacity and inefficient use of resources. Therefore, it can be inferred that building the third wharf is not a cost-effective option for Superior Grain Elevator Inc. unless the demurrage savings increase to $360,000. This amount is necessary to achieve the company’s goal of a 20% rate of return on the investment per season.
REFERENCES
- Bell, P. (1998). Superior Grain Elevator, Inc. Ivey Management Services. Version: (A) 1999-03-04
