A palm-oil mill in Ebolowa: borrow or stay small?
A small palm-oil processing cooperative in Ebolowa currently produces 20 tonnes of crude palm oil a month. It sells at 900,000 FCFA per tonne. Its monthly fixed costs are 6 million FCFA for rent, permanent staff and loan repayment. Variable costs are 500,000 FCFA per tonne. A supplier offers a second-hand press for 18 million FCFA. With it, output could rise to 30 tonnes a month, variable costs would fall to 450,000 FCFA per tonne, but fixed costs would rise by 2 million FCFA a month because of maintenance and a new loan. The cooperative can borrow at 12% a year. The local market can absorb 30 tonnes only if the price falls to 850,000 FCFA per tonne. The cooperative has no cash reserves and 25 members who share profits equally.
1. Calculate current monthly profit and the break-even output. Show your working.
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Current revenue = 20 × 900,000 = 18,000,000 FCFA. Current variable cost = 20 × 500,000 = 10,000,000 FCFA. Current fixed cost = 6,000,000 FCFA. Total cost = 16,000,000 FCFA. Profit = 18,000,000 − 16,000,000 = 2,000,000 FCFA per month.
Break-even output = fixed cost ÷ contribution per tonne. Contribution per tonne = price − average variable cost = 900,000 − 500,000 = 400,000 FCFA. Break-even = 6,000,000 ÷ 400,000 = 15 tonnes per month. Current output of 20 tonnes gives a margin of safety of 5 tonnes. Profit per member is 2,000,000 ÷ 25 = 80,000 FCFA a month. The cooperative is profitable but not highly cushioned: a fall in output below 15 tonnes, or a price fall, would wipe out profit.
2. Calculate the profit if the press is bought and output is 30 tonnes at 850,000 FCFA. Should the cooperative invest?
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New revenue = 30 × 850,000 = 25,500,000 FCFA. New variable cost = 30 × 450,000 = 13,500,000 FCFA. New fixed cost = 6,000,000 + 2,000,000 = 8,000,000 FCFA. Total cost = 21,500,000 FCFA. Profit = 25,500,000 − 21,500,000 = 4,000,000 FCFA per month.
If the 2 million FCFA rise in fixed cost does not already include interest, the annual interest on 18 million FCFA at 12% is 2.16 million FCFA, or 180,000 FCFA a month; profit would then be about 3.82 million FCFA. Even so, profit is higher than the current 2 million FCFA. New break-even output = 8,000,000 ÷ (850,000 − 450,000) = 8,000,000 ÷ 400,000 = 20 tonnes. At 30 tonnes, the margin of safety is 10 tonnes. The investment looks worthwhile if the cooperative can reliably sell 30 tonnes at 850,000 FCFA and manage the loan. But the price must fall to sell the extra output, and the cooperative has no cash reserves, so the risk is real.
3. Explain economies of scale and evaluate whether the cooperative should borrow, considering risk and members' income.
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Economies of scale occur when average cost falls as output rises. The new press spreads the fixed costs over 30 tonnes instead of 20, and lowers variable cost per tonne from 500,000 to 450,000 FCFA. Average cost falls from 16,000,000 ÷ 20 = 800,000 FCFA per tonne to 21,500,000 ÷ 30 = 716,667 FCFA per tonne. This is mainly a technical and fixed-cost economy.
However, the cooperative must weigh the gain against risk. Profit per member would rise from 80,000 to 160,000 FCFA a month if 4 million FCFA profit is achieved, but the loan must be serviced even in a bad month. The market price falls to 850,000 FCFA, and a further fall would reduce the margin. If output falls below 20 tonnes, the new mill makes a loss. The cooperative should borrow only if it has a firm buyer, a maintenance plan, and a cash reserve; otherwise a smaller upgrade or a shared press with another cooperative may be safer. The judgement is cautiously favourable, not automatic.