Executive summary
Harvest Company should choose Option 1 because it has a higher level of certainty than Option 1 in attracting clients. The business’ key profitability driver is the tipping fee charged by Harvest for receiving solid waste. Higher tipping fees are only guaranteed if the firm can attract a higher number of clients. Clients are likely to avoid high labor cost associated with separating waste. Separation of waste from source does not eliminate inorganic contaminants completely. If Option 2 fails to attract solid waste to fill 80% of its capacity, it will generate less profit than Option 1. Option 2 relies more on recyclable materials than Option 1. The firm has to offer incentives in Option 2 to attract recyclables. The compost in Option 1 incurs landfill costs. Sorting the compost to be saleable may provide economic benefits to the society.
Brief description of the firm and its environment
Harvest Company targets sources that produce a higher proportion of organic waste than inorganic waste. The firm’s profitability is driven by the collection of tipping fees, and the sale of compost and electricity (Lee, Ata and Tongarlak 6). The first has two options for its new facility. The business environment is governed by strict regulation for the control of environmental pollution.
Brief description of problems
Option 2 may fail to attract solid waste to fill its 50-ton capacity. The profitability of the new facility is uncertain under Option 2. Option 1 has higher depreciation costs, labor costs, and landfill costs. Option 2’s compost is not saleable.
Revenues and costs
In Harvest (A), the firm generates $8,076,000 as pre-tax profit. The revenue it generates amounts to $12,046,000 annually (see Table 1). The costs amount to $3,970,000.
The revenues are generated from 200,000 tons of solid waste (Lee, Ata and Tongarlak 6). The average cost of the tipping fee charged in North America has been used instead of Richmond or British Columbia charges. The charges for the two states are missing in the table of charges. The average cost used is $42.08 per ton. The rate would have been lower. However, the average became preferred considering the charges in Option 1 ($80 per ton) and Option 2 ($50 per ton).
In Harvest (A), there is an assumption that 55% of processed mass is converted into compost manure. Biogas production accounts for 40% of the initial mass. 5% is considered the lost mass in the methane and compost processing. Tipping fees are calculated at 200,000 tons multiplied by $42.08 (see Table 1). Compost sales is obtained by taking the proportion of the original mass that is converted into compost and multiplying it by the rate per ton (55%*200,000*$40). The electricity revenue also considers the proportion of original mass used to generate electricity and the efficiency of converting the mass into methane. There is 65% efficiency in conversion, which is the lowest possible. The price of electricity per kWh is the average between the highest price and the lowest price (($0.6+0.11) /2 = $0.09). One ton of waste produces 250 kWh. The electricity generation revenue is obtained as 40%*200,000 tons* 65%*250kWh * $0.09 per kWh. The premium received is obtained by multiplying the kilowatt hours generated by the premium rate ($0.02). There are four sources of revenues as indicated in Table 1. They provide the firm with total revenues amounting to $12,046,000.
The costs are derived from depreciation allowance, labor, and operating costs. Depreciation assumes that the $10-million equipment has a salvage value of $500,000 and 20 years of useful life. Depreciation is calculated by deducting salvage value from the cost and dividing the difference by the useful life of equipment or plant (Godwin and Alderman 187). The depreciation allowance is calculated as (10,000,000 – 500,000) /20. The engine for electricity generation has a salvage value of $200,000 and 10 years of useful life. The depreciation is calculated as (2,000,000 – 200,000) /10. Annually, labor cost assumes that the supervisor receives benefits amounting to $20,000 and the two operators $10,000 each. The supervisor earns a total of $70,000 and the two operators earn $50,000 each. The firm processes 200,000 tons annually. It will require 4 facilities to process 200,000 tons. The depreciation costs and labor costs assume a 50-ton facility. As a result, the depreciation and labor costs have been multiplied by 4 to reflect the number of facilities required to carry out processing. The total cost amounts to $3,970,000 (see Table 1). The pre-tax profit is obtained by deducting costs from revenues to get $8,076,000 (Drake and Fabozzi 216).
Table 1
The profitability driver
In the business, the profitability driver is the tipping fee. In the initial business, the tipping fee contributed 69.9% of the revenue generated by the firm. In Option 1, the firm is likely to generate 82.7% of the revenues from tipping fees (see Table 2). In Option 2, tipping fees may account for 52.5% when it operates at full capacity. In Option 2, the sale of recyclables is the second driver of profitability. Recyclables account for 27.3% of revenues (see Table 3). If the mass of recyclable waste doubles, it would become the key driver of profitability. The profitability should incur lower costs relative to revenues (Rich et al. 935). Tipping fees take less time and are more efficient. Tipping fees revenue incurs fewer costs compared with other processes. It incurs costs on the cashier’s labor costs and depreciation allowance on the scale. In the three tables, tipping fee is the key profitability driver.
Table 2
In Option 1, the firm receives solid waste that is 75% clean (Lee, Ata and Tongarlak 17). The inorganic matter accounts for 25% solid waste received. Revenue from tipping fees is obtained by multiplying the number of tons by the rate per ton (50,000*$80). The compost from Option 1 is not saleable. It does not contribute to revenue. Electricity generation is the second source of revenue. The firm decides to commit more tons to methane generation. The calculations involve the assumption that 60% of the initial mass is used in electricity generation. A ton of waste generates 250 kWh. The revenue generated by electricity generation is obtained as 60%*50,000 tons*65% methane conversion efficiency * 250 kWh per ton * 0.09 per kWh. It gives an amount equal to $438,750 as shown in Table 2. The premium received for renewable energy generation is obtained at a rate of $0.02. The full amount received is calculated as 60%*50,000*65%*250*0.02 amounting to $97,500. Revenue from recyclables is calculated as 60%*25%*$40*50,000 to obtain $300,000. $40 is the rate charged per ton of recyclables. 60% is the percentage of recyclables in 1 ton of inorganic contaminants. 25% is the proportion of contaminants from the initial mass of solid waste. The sum of revenues from the four sources equals $4,836,250.
The costs amount to $2,283,270 in Option1. Labor costs are obtained by multiplying the number of workers by the hourly rate, and the number of hours in a day. It is also multiplied by the number of days in a week, and the number of weeks in a year. The technician is paid a salary of 70,000 inclusive of benefits. The labor cost is calculated as 8 workers* 8 hours a day * 6 days a week * 52 weeks * $15 per hour + $70,000. It gives a total of $359,520. Depreciation on pre-processing plant assumes a salvage value of $250,000 after 8 years. Depreciation allowance for the pre-processing plant is calculated as (4,000,000 – 250,000) /8). Depreciation on plant and engine is similar to Harvest (A) for a single processing facility. Option 1 also assumes that 40,000 tons will need to be land filled because the compost cannot be sold. The landfill rate is $10 per ton amounting to $400,000.
The difference between the total revenues and total costs provides pre-tax income. Option 1 has a pre-tax income of $2,552,980. It is less than the one for Option 2 if Option 2 operates at full capacity and 85% capacity (see Table 3).
Table 3
Option 2 has lower labor costs compared with Option 1. It needs a supervisor and two operators similar to the facilities in Harvest (A). Depreciation on plant and engine are similar to the ones in Harvest (A). It differs from Harvest (A) through the land filling costs for contaminants sorted out. The costs are incurred on the 5% of the initial mass at a rate of $10 per ton (Lee, Ata and Tongarlak 17). Maintenance, utilities and administration cost are similar to those of Option 1. When the facility is not operating at full capacity, it reduces revenues through tipping fees, sale of compost, electricity generation, premium for renewable energy generation, and the sale of recyclables. Their values are reduced by the proportion of the reduction in operating capacity. In the costs part, only the land filling costs are reduced in a similar manner (see Table 3). Option 2 assumes that the recyclables are not part of the organic wastes separated from the source. The recyclables should be about a quarter of the received organic matter because Harvest Company receives the wastes from firms that produce 70% to 75% organic wastes (Lee, Ata and Tongarlak 17). In the calculations, recyclables are expected to be 10,000 tons considering the firm collects 50,000 tons of organic matter.
Conditions for profitability
Option 2 will be more profitable than Option 1 provided that the facility operates at full capacity or 85% capacity (see Table 3). Option 1 will be the better option when Option 2 operates at a capacity lower than 80%. Option 1 will have no problem attracting clients because clients do not have to incur the high cost of labor for separation. As a result, Option 1 will be more likely to operate at full capacity. In Option 2, clients would still incur separation costs even if they train users within their premises to dispose waste in the right bins or containers. The high cost of labor may cause client firms to be fewer in Option 2.
Recyclables are a major source of revenues in Option 2. Harvest Company will need to provide clients with additional benefits to attract high quantities of recyclable waste. Clients may choose to find a separate market for recyclable waste rather than Harvest.
Change in process flow
The process flow in the old facilities. Option 1 the process flow changes involve adding a pre-processing section. The pre-processing section uses machines that use magnetism and air lifters to remove inorganic matter. The process is completed by a manual separation using laborers. There are recyclable wastes recovered after sorting that are available for sale. The changes also affect the end products. Compost produced is taken to a landfill rather than for sale.
In Option 2, only one change occurs in the flow process. Recyclables for sale are taken from the tipping floor. The recyclables had been separated from the source.
Criteria for option selection
Profitability is the first criterion for option selection. Both options provide high levels of profitability. The next criterion for selection is uncertainty (Dixit and Pindyck 320). Option 2, has a high level of uncertainty regarding the attractiveness to clients. Tipping fees are the main source of revenues in both cases. The firm has to choose the option that attracts the highest number of clients with a high level of certainty. Option 1 is more preferable because its profitability is more certain.
Recommendations
- If the firm selects Option 1, it has to offer an incentive to attract recyclable wastes as well.
- If the firm selects Option 2, it can employ two more workers to sort the compost. Sorting the compost will make it saleable. The highest number of workers that it can hire before it incur losses in the sorting process is two at the rate of $15 per hour.
Analysis of recommendations
Recyclables are a major source of revenues in Option 2. The firm should waiver tipping fees for clients that deliver recyclables according to the number of tons of recyclables they deliver. For example, a client that delivers 8 tons of organic matter and 2 tons of recyclables can pay tipping fees for 6 tons instead of 8. The recyclables are sold at $130 a ton and the tipping fee is charged at $50 a ton (Lee, Ata and Tongarlak 17).
In Option 1, the compost is sent to a landfill at a cost of $10 a ton. If the compost is sorted, it will be sold for at least $20 a ton. The sum of the two indicates that the firm has to spend $30 on sorting before it can incur accounting losses. If it spends $30 on sorting, it will generate zero accounting profits (Drake and Fabozzi 216). However, it will generate economic benefits to the society by preventing the continuous depletion of soil and creating two additional opportunities for employment. Its profitability will not change unless it uses a different number of workers. For the second recommendation to be feasible, the two workers must be able to sort at least half a ton in an hour each and are paid $15 per hour. If they can work faster than that, the firm will generate accounting profits from the sorting process.
Works Cited
Dixit, Avinash, and Robert Pindyck. Investment under Uncertainty, Princeton, NJ: Princeton University Press, 2012. Print.
Drake, Pamela, and Frank Fabozzi. Analysis of Financial Statements, Hoboken, NJ: John Wiley & Sons, 2012. Print.
Godwin, Norman, and Wayne Alderman. Financial ACCT. 2nd ed. 2012. Mason, OH: South-Western Cengage Learning. Print.
Lee, Deishin, Baris Ata and Mustafa Tongarlak. “Harvest: Organic Waste Recycling with Energy Recovery (A).” Harvard Business School 2010: 1-18. Print.
Rich, Jay, Jeff Jones, Dan Heitger, Marryanne Mowen, and Don Hansen. Cornerstones of Financial & Managerial Accounting. 2nd ed. 2012. Mason, OH: South-Western Cengage Learning. Print.