Superior Grain Elevator Superior Grain Elevator SUPERIOR GRAIN ELEVATOR, INC. EXECUTIVE SUMMARY Superior Grain Elevator was located at Thunder Bay, Ontario, Canada’s third busiest port. With 14 giant grain elevators, Superior was able to load ships constantly sending grain to all parts of Eastern Canada and the globe. The ships were contracted for by agents who lined up the required tonnage of shipping capacity to fulfill the various contracts held with Superior.
Although the agents tried to arrange for ships to arrive at Thunder Bay in a steady stream, the vagaries of lockage transfer times in the Seaway resulted in quite variable arrival times, at times forcing arriving ships to anchor when both wharfs were busy. This resulted in SGE having to incur demurrage charges at a rate of $2000 per day. Mike Armstrong, manager of port facilities for SGE, had just learned that the Canadian Government had negotiated a 5-year contract with Poland, and that Superior had been allocated some of the shipments.
However, the two wharfs Superior currently had might not be enough to carry out the contract efficiently, and building a third wharf was being considered. The third wharf was estimated to cost $1,500,000. Superior Grain Elevator needs to consider the pros and cons of building a third wharf and decide if the benefits & savings will offset the cost of the investment. After careful consideration and analysis, using the ROI, NPV, FV formulas and @Risk, we do not recommend for SGE to build a third wharf.
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). BACKGROUND Superior Grain Elevator’s 14 giant grain elevators gave it a prominent position on the Thunder Bay waterfront in Ontario, Canada. Thunder Bay was Canada’s third busiest port and was very important for the shipment of grain. Superior’s operations centered around the railroads and the Seaway.
Trains of specially built railcars carried the grain to Thunder Bay where the grain was stored in lakefront elevators for loading into the freighters. Apart from the four months of winter when the Seaway was closed because of ice, Superior loaded ships constantly sending grain to all parts of Eastern Canada and the globe. The ships were contracted for by agents who lined up the required tonnage of shipping capacity to fulfill the various contracts held with Superior.
Although the agents tried to arrange for ships to arrive at Thunder Bay in a steady stream, the vagaries of lockage transfer times in the Seaway resulted in quite variable arrival times. If Superior’s two wharfs were both busy, the arriving ships had to anchor in the lake, and Superior had to pay a standard demurrage charge at a rate of $2000 per day. Mike Armstrong, manager of port facilities for SGE, had just learned that the Canadian Government had negotiated a five-year, 8 million tonne grain deal with Poland, and that Superior had been allocated 20 shipments to Poland for each year of the 5 years of the contract.
This new contract might be the opportunity SGE had been waiting for to consider building a third wharf. PROBLEM STATEMENT For some time, Superior had thought of adding a third wharf and the Polish contract could make the third wharf a profitable option. The third wharf was estimated to cost $1,500,000 and needed a 20% return on investment. Superior Grain Elevator needs to consider the pros and cons of building a third wharf and decide if the benefits & savings will offset the cost of the investment. CASE QUESTIONS 1. 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. 2. 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. 3. 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). 4. 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. Figure 1 The cost of the investment of building the third wharf is 1. million dollars which will not produce the expected rate of return of 20% within a period of five years; instead it will produce a negative rate of return of 23. 29%. The Net Present Value & Future Value will also help sustain the analysis. In order to calculate the NPV we considered the mean savings from the investment per season of $230,115 as cash flow for duration of five years with an expected rate of return of 20% and the cost of the investment of $1,500,000 which gave us a negative $676,511. 34. Additionally the FV of the project gave us $5,787,393. 72.
Consequently, this project will not only be unsuccessful but also cause financial difficulties to the company and the third wharf should not be built. ANALYSIS Based on our simulation, financial and capacity analysis we were able to determine that building the third wharf would not generate sufficient savings to cover the cost of the investment. At Risk was used to run the simulation analysis in order to determine the mean, max, min and standard deviations of the savings as shown in Figure 1. The mean of 230,115. 58 per season indicates the average demurrage savings that the third wharf would enerate. However, if the mean is multiplied by 5 seasons a savings of $1,150,575 would be generated and would not cover the investment cost of $1. 5 million. The standard deviation of $138,898. 35 provides the best and worst case scenario with the best being $369013. 4 and worst at $91217. 23. Furthermore, we analyzed the Net Present Value, Future value and Return on Investment. We calculated the NPV by using the mean savings as cash flow for a period of five years with the expected rate of return of 20% and an initial investment of $1. 5 million which gave us a negative outcome of $676,511. 4. The future value gave us -$5,787,393. The ROI was determined by taking the cost of investment minus the savings during the five seasons and then divided by cost of investment equaling -23. 29%. Lastly, we looked at the capacity and utilization of the wharfs to determine if the adding the third wharf would improve efficiency. Before the Polish contract was in place Superior Grain Elevator was running at 100% capacity utilization with two wharfs. Now with the additional 20 ships from the Polish contract; if they keep running the business with two wharfs they would be at a capacity of 117%.
On the other hand, if they decide to build the third wharf they would only be using 70% capacity and so resources would not be utilized efficiently. We can conclude that building the third wharf is not a cost effective alternative for Superior Grain Elevator Inc. unless the demurrage savings increase to $360,000, which is the amount of cash flow needed per season in order to get to the company goal of 20% Rate of return on the investment. CONCLUSION & RECOMMENDATIONS REFERENCES Bell, P. (1998). Superior Grain Elevator, Inc. Ivey Management Services. Version: (A) 1999-03-04