Case Assignment

Background

Mike Ibanez had a big decision to make. He had inherited his families vegetable business. Ibanez Produce grew, harvested, packaged, and sold produce. Mike was concerned because a large storm was approaching and he had to make a decision regarding his lettuce crop.

Ibanez Produce had around 10,000 acres in cultivation and lettuce made up around 25% of the total crop value. Mike’s concern was that the storm might bring severe winds and dust. Rain was not a major concern, but high winds and blowing dust reeked havoc on the lettuce crop. The high winds generally tear apart the lettuce and the dust renders the crop almost unsalvageable.

The Solution

From his Father’s records, he had read that if he applied water combined with standard wax a residue would form on the lettuce and the crop could be saved. He knew that if the storm did come he could lose the whole crop if not protected. However, he didn’t know how much the solution would cost him or how much he should pay.

The Outcomes

Mike knew that the storm had about a 50/50 chance of hitting. He also knew that if the storm did not hit and he did protect his crops the residue left might cause problems during harvest. After conversing with his Coop Extension officer, he had surmised that the probability of the residue causing problems was around 40%. If this problem did occur Mike would only get 80% of his normal crop.

Mike usually sold his lettuce with a $0.2 margin per pound. Normally the crop was around 800,000 lbs. If he did not protect his crop and the storm hit he maybe could salvage 10% of the lettuce. However, if he did protect and the storm did hit there was no guarantee that 100% of the crop would be saved.

In fact, from the information the Coop Extension officer had provided there was around a 65% chance that the he would lose part of his crop even if he did take protective measures and the storm hit. He surmised that three scenarios could occur in this case: a 85% salvage rate, a 70% salvage rate, and a 45% salvage rate. Mike thought these three scenarios had equal probability.

Mike’s Decision Problem

Mike also knew that if he harvested right now he could make $0.08 margin on the total crop of lettuce. Overall operating costs were about the same in any situation. Mike needs to know if he should protect his crop and a starting point on what he should pay. Help Mike with his dilemma.

Discussion Questions:

1. What is Mike’s expected gross revenue if he harvests now? What is his gross expected revenue if he does nothing and waits out the storm? What are the risks in choosing to harvest now or in waiting out the storm?

2. Is it a good idea for Mike to protect his crop? Why? What is the maximum that Mike should pay for the protection?

3. If the probability the storm would hit is 5%, what should Mike do? If the probability the storm would hit is 65%, what is Mike’s best choice?

Provide a full sensitivity analysis for Question 3.

ANSWER

A Decision Dilemma: Weathering the Storm for Mike Ibanez’s Vegetable Business

Introduction

Mike Ibanez, the owner of Ibanez Produce, is faced with a significant decision regarding his lettuce crop. With a large storm approaching, he must determine whether to protect his crops from potential damage caused by high winds and blowing dust. This essay will delve into the analysis of Mike’s situation, considering the potential outcomes and probabilities associated with his choices.

Expected Gross Revenue

Harvesting Now
If Mike chooses to harvest his lettuce crop now, he can expect to make a margin of $0.08 per pound. With a typical crop size of 800,000 lbs, his expected gross revenue would be: 800,000 lbs * $0.08/lb = $64,000.

Waiting Out the Storm
On the other hand, if Mike decides to wait out the storm and protect his crop, he faces a series of potential outcomes based on probabilities:

– Probability of Storm Hitting (50%): If the storm hits, there is a 65% chance that the protective measures will not guarantee a 100% salvage rate. Instead, the potential salvage rates are 85%, 70%, and 45%, each with an equal probability (1/3).

Expected Gross Revenue (Storm Hits):
(65% * 85% * 800,000 lbs * $0.2/lb) + (65% * 70% * 800,000 lbs * $0.2/lb) + (65% * 45% * 800,000 lbs * $0.2/lb) = $93,400

– Probability of No Storm (50%): If the storm doesn’t hit, there is a 40% chance that the residue from the protective measures may cause problems during harvest, resulting in only 80% of the normal crop.

Expected Gross Revenue (No Storm):
(50% * 80% * 800,000 lbs * $0.2/lb) = $64,000

Risks in Choosing to Harvest Now or Wait:

Harvesting Now:
The risk in harvesting now lies in the possibility that the storm may not hit, and Mike could lose the chance to benefit from a potentially higher gross revenue if the protective measures were successful. Additionally, he would forego the 50% chance of having a normal crop size.

Waiting Out the Storm:
The risks in waiting out the storm are twofold. Firstly, if the storm does not hit, Mike faces the potential problem caused by the residue, leading to a lower crop yield. Secondly, if the storm hits, the protective measures may not ensure a 100% salvage rate, resulting in varying degrees of crop loss.

Protecting the Crop and Maximum Payment

Considering the probabilities and potential outcomes, it is advisable for Mike to protect his crop. The expected gross revenue of $93,400 in the event of a storm hitting is significantly higher than the $64,000 revenue from harvesting now.

To determine the maximum amount Mike should pay for the protection, he needs to weigh the additional cost against the potential gain. The optimal payment should be less than the difference between the expected gross revenue with protection and the current gross revenue without protection, i.e. $93,400 – $64,000 = $29,400.

Sensitivity Analysis for Different Storm Probabilities

Probability of Storm Hitting (5%):
In this scenario, the probability of the storm hitting is very low. Therefore, the best choice for Mike would be to harvest now, as the potential gain from waiting is minimal compared to the risk of losing the chance to harvest a regular crop.

Probability of Storm Hitting (65%):
At this probability level, it is still beneficial for Mike to protect his crop. The expected gross revenue with protection is $93,400, while the expected gross revenue without protection is $64,000. Thus, the gain from protecting the crop outweighs the additional cost.

Conclusion

Mike Ibanez’s decision to protect his lettuce crop from the approaching storm is a prudent one, given the potential consequences of crop loss due to high winds and blowing dust. With a comprehensive analysis of probabilities and expected revenues, the best course of action is evident. By protecting the crop, Mike can secure a higher expected gross revenue compared to harvesting now or risking the storm without protective measures. A sensitivity analysis confirms that protecting the crop remains the optimal choice even with varying probabilities of the storm hitting.