AquaFish_Additional Information CMA

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Module 3 Assignment 1

Practice Case Examination

Additional Information

(Time Allowed: 4 hours)

Notes:

i) Candidates must not identify themselves in answering the question.

ii) All answers must be written on official answer sheets or in official electronic files.Work done on the question paper or on the Backgrounder will NOTbe marked.

iii) Included in the examination envelope is a standard supplement consisting offormulae and tables that may be useful for answering the question.

iv) Examination answer sheets MUST NOT BE REMOVED from the examinationwriting centre, except for the Instruction Sheet to Electronic Exam Writer, ifapplicable.All used and unused answer sheets, working papers, Backgrounder,

Additional Information, the supplement and, if applicable, a USB key containingelectronic answer files must be sealed in the examination envelope and submittedto the presiding officer before the candidate leaves the examination room.Candidates writing the examination electronically must keep the Instruction Sheet toElectronic Exam Writers, which provides instructions for uploading their responsesfollowing the examination.

v) Only the following models of calculators are authorized for use on the Case

Examination:

1. Texas Instruments TI BA II Plus (including the professional model)2. Hewlett Packard HP 10bII+ (or HP 10bll)3. Sharp EL-738C (or EL-738)


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Additional Information Practice Case Examination M3A1

Page 2 (8 pages) CMA Canada

Aqua Fish Canada Inc. (AFC)Additional Information

May 2009 to April 2011 Update

Over the past two years, AFC has faced more intense competition, particularly fromaquaculturists in Chile. In addition, Chilean output has increased the supply of salmon andthe Canadian dollar has strengthened in relation to the U.S. dollar. As a result, AFC hasbeen unable to meet its budgeted revenue targets. Stocks of unsold harvestable fish haveincreased, as well as the corresponding cost of maintaining the fish, and the companybarely made a profit in fiscal 2011.

In January 2011, AFC lost one of its largest retail customers, S&F Seafood, to a newsalmon aquaculture firm, Nu-Farm Inc. This new competitor uses a sophisticated,computerized system for supply chain and product distribution functions. The systemallows Nu-Farm to establish web links with customers, such as S&F Seafood, and tomanage orders and deliveries directly for each of the customers retail outlets. This haseliminated the need for customers to make separate arrangements to receive andwarehouse fresh fish, and to ultimately distribute the fish to their retail locations.

In February 2011, 2,000 kilograms of fish from Site 4 were rejected by three importantcustomers, two of which are located in the United States. An internal investigation revealedthat two employees at Site 4 had neglected to follow established procedures and failed toreject some fish that did not meet quality standards and were not certified by the staffveterinarian.

In April 2011, employees neglected to secure some of the net-pens at Site 3. During astorm, more than 300,000 kilograms of young fish escaped from these net-pens and most

were subsequently lost to predators. Although the companys property and liabilityinsurance covers criminal theft of fish, it does not cover the loss of fish from disease,parasites, escape, or predators. In addition, there is no liability coverage with respect tofood poisoning or diseases caused by the salmon, or environmental damage caused bythe farms operations. The lost salmon had a book inventory value of $690,000, which waswritten off in fiscal 2011. The ultimate sales value of the lost fish had they grown toharvestable weight is approximately $1.5 million. It will cost $200,000 to repair thedamaged pens.

Domestic and Export Markets

Guy Mills is dissatisfied with the companys geographic sales distribution, which has not

changed since 2008, and would like to increase overseas sales. He has requested JulietteMaise to investigate the possibility of opening an overseas sales office. Experts predictthat demand for all forms of salmon will grow at a record pace in overseas markets,particularly in developing countries. It is expected that Canadas international reputation forsalmon and other fish will remain high.

A market analysis by a respected source, published in May 2011, indicates that the marketfor fresh salmon is maturing very rapidly in Canada and the U.S., as consumer tastes


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Practice Case Examination M3A1 Additional Information

CMA Canada Page 3 (8 pages)

become more sophisticated and demand begins to shift to shellfish and various exotic,imported fish.

New packaging methods have been developed for mussels, which has enabled live freshmussels to be exported to markets at greater distances from the farms. The wholesalemarket price for Canadian mussels has remained stable at about $1.40 per kg, but is

expected to increase to $1.50 over the next few years.

In the past few years, global supplies of American oysters have decreased after hurricanesdestroyed a significant percentage of the oyster farms in the southern U.S. At the sametime, the popularity of these oysters by consumers in North America and Europe has beenincreasing. As a result, the market price for American oysters farmed in Canadasignificantly increased from $1.80 per kg in 2008 to $2.70 per kg in 2011. The re-established farms in the southern U.S. are expected to have their first new harvests inanother year or two.

New Strategic Goals

The board of directors met in May 2011 after receiving the financial statements for 2011.Guy Mills provided the board with a summary of selected site and segment data (see

Appendix 1), and reported that the decreased profits in 2011 were caused by the Site 3problems, the decrease in market value, the strengthening Canadian dollar versus the U.S.dollar, and the increased feed costs. He also indicated that he expected the four sites toyield an average of 3.8 million kilograms (950,000 kilograms per site) of harvested fish peryear, assuming that no further unusual losses were incurred.

Given the current market conditions and the risk of having to decrease prices or loseexport sales to the U.S., the board decided that the company should move into othermarkets and diversify into shellfish farming. No dividends would be paid for the next year

or two to free up some cash to invest in new projects. The board directed Mills toinvestigate establishing shellfish aquaculture sites and develop a business strategy forincreasing the profitability of the current salmon operations. They indicated that anyproposed investment should generate a minimum after-tax return of 10% within five years.

Shellfish Aquaculture Opportunity

Mills explored opportunities for diversifying into shellfish aquaculture. He found twopotential opportunities (a mussel farm and an oyster farm) and wondered which oneshould be pursued or whether both should be pursued. A summary of the costs and yieldsfor establishing these farms is provided in Appendix 2.

Project Blue Wave

Over the past two years, Dr. Lily Stern has been investigating what makes some salmon inan aquaculture environment grow more quickly than others, have better diseaseresistance, and develop higher-quality flesh. Her studies have led her to submit a proposalfor Project Blue Wave (see Appendix 3), which would use leading-edge geneticengineering to develop a strain of Atlantic salmon with superior qualities specifically suitedto aquaculture. Dr. Stern insists that this is a new approach to finfish aquaculture and feelsthat it would revolutionize the industry.


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Executive Meeting June 15, 2011

Mills suggested that AFC could increase revenues by pursuing overseas markets moreaggressively. He also indicated that the company should find ways to decrease operatingcosts. He presented the two options for expanding into shellfish aquaculture and Dr.Sterns Project Blue Wave proposal for discussion and asked for any new ideas to achieve

the boards goals.Mills also reported that residents in the vicinity of Site 3 were investigating the possibility oflaunching a lawsuit against AFC if they could gather enough evidence to prove that theescaped fish were causing environmental damage and contaminating the wild fish. In thepast, similar lawsuits have had a 10% success rate with damages amounting to$10 million.

Vanic questioned the wisdom of establishing a mussel farm in PEI. He indicated that manysuch farms become infested with an invasive parasite that attaches itself to the growingmussels. The parasites do not have a significant impact on the growth period or meatyields of mussels; however, maintenance, harvest and distribution costs are significantly

increased (20% more variable production, 10% more fixed production, and 14% morevariable distribution costs). Employees also dislike handling mussels infested with theparasite.

Egin indicated that only about 25% of mussel farms get infected with the parasite. He wasmore interested in the Project Blue Wave proposal and suggested that it had a very goodchance of realizing greater than market returns. He indicated that the R&D department hadbeen conducting some preliminary research on genetic engineering and the scientistsbelieve they are on the brink of delivering results, if supported with a little more investment.

Jacques Dubois wondered whether the chances of successfully developing a faster-growing salmon were much lower than Egin or Dr. Stern realized and that a much largeraquaculture organization, or the government, would be doing this research if it were aproject worth pursuing. He felt that too much money had already been spent on R&D andnot enough on operational efficiencies, supply chain management, and technologies. Afterthe meeting, Mills directed Adam Rice, Controller, to review the companys strategicoptions and operational issues.

Other Information

Rice began by interviewing various staff members, and made the following notes:

1. The variability of the fishing industry has made banks very cautious. Consequently, theEastern Bank of Canada would be willing to provide a loan of no more than $3 million

at an annual interest rate of 8%, on the condition that AFC maintain a gross profitmargin of at least 20%.

2. Maise has determined that Paris, France would be an ideal location for an overseassales office. Space could be leased for CDN$5,000 per month and a local salespersoncould be hired for an annual base salary of CDN$20,000 plus a four percent salescommission. Maise estimates that this office could generate annual sales of up to500,000 kilograms of fresh whole salmon. She also indicated that there is a strongmarket for oysters in France, if they could be transported in an economical manner.


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3. Rob Vanic predicts that world fuel prices will continue to increase and that the risk ofspoilage of fresh seafood shipped overseas will double. In fiscal 2011, two percent ofoverseas shipments of salmon were lost or spoiled before reaching the customers.

4. An investigation of the variable cost variances at Sites 3 and 4 revealed that theemployees were overfeeding the fish, resulting in an excess amount of feed falling to

the ocean floor. At Sites 1 and 2, the employees are well trained and experienced.

5. In June 2011, an important, high-potential overseas customer asked an AFCsalesperson to ship crates of fish purchased for US$6,000 with documentation thatstated the value as US$2,000. Apparently, this request was for customs purposes. Thesalesperson consulted Maise, who indicated that the companys policy to please thecustomer applied in this and all other cases. The salesperson brought the matter toRices attention.

6. Jacques Dubois stated that in April 2011, the environmental legislation changed withrespect to aquaculture sites. Effective that date, the company now has a legalobligation to pay for dismantling the sites at the end of their useful lives. Dubois hasestimated that the present value of this obligation at April 30, 2011, is $300 thousand.

7. Jacques Dubois also discussed his concerns regarding the current bonus calculationfor the employees. Currently, the employees share in the profits of the company, andhistorically this bonus has been calculated as 10% of net earnings. However, Duboissuggests Rice review whether this calculation is still fair given the companys adoptionof ASPE and the impact on the net earnings of these new accounting policies.

8. Costs of preliminary research on genetic engineering have been expensed in the yearincurred. Genetic engineering is a common practice in the agriculture and livestockindustries. Proponents of organic and natural foods have increasingly complained

about the ethical issues surrounding genetic tampering.9. A discount rate of 10% after taxes is used for evaluating capital investments.

10. The company uses a 30% tax rate for planning purposes.

Required:

As Adam Rice, CMA, develop an integrated report for Guy Mills, advising him on whichbusiness strategies to follow in order to meet the corporate strategic goals set by the boardof directors, as well as any other issues and concerns requiring his attention. Includedetails of your analyses, supported recommendations, and an action plan to implementyour recommendations. In undertaking this task, you will need to take into considerationyour background knowledgeof the organization and industry as well as the additionalinformation provided. Assume the capital cost allowance rate for equipment and facilities ataquaculture sites is 20%. Finally, the 2011 financial statements have not yet beenfinalized. Make any adjustments that might be required based on the information providedin the case.


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Appendix 1Aqua Fish Canada Inc. (AFC)

Selected Data for the Year Ended April 30, 2011

Selected Site Data:

Site 1 Site 2 Site 3* Site 4AFC

Overall*

Harvested fish sold (kg) 905,023 904,867 773,218 796,704 3,379,812

Normal expected annualcapacity of harvestable fish (kg) 950,000 950,000 950,000 950,000 3,800,000

Average growth rate (months) 30 30 34 32 31

Full cost of sales per kg:

Hatching and growing $2.82 $2.85 $4.10* $3.06 $3.18*

Harvesting 0.09 0.09 0.09 0.09 0.09

Distribution 0.15 0.14 0.15 0.16 0.15Full cost per kg sold $3.06 $3.08 $4.34* $3.31 $3.42*

Average price per kg $4.20 $4.20 $4.20 $4.20 $4.20

Variable cost per kg 2.18 2.21 3.29* 2.28 2.46*

Contribution margin per kg $2.02 $1.99 $0.91* $1.92 $1.74*

* Cost of sales includes the $690,000 cost of lost fish at Site 3. Excluding this loss, costs andcontribution margins for Site 3 and AFC overall would be as follows:

Site 3 AFC Overall

Hatching and growing $3.20 $2.97

Full cost per kg sold $3.44 $3.21

Variable cost per kg $2.39 $2.26

Contribution margin per kg $1.81 $1.94

Selected Segment Data:

Processors Retailers RestaurantsOverseasRetailers AFC Overall

Sales (kg) 2,028,878 1,000,000 182,934 168,000 3,379,812

Sales (CDN$) $8,320,880 $4,230,940 $885,484 $757,906 $14,195,210

Price per kg $4.10 $4.23 $4.84 $4.51 $4.20

Distribution costper kg $0.09 $0.14 $0.14 $0.93 $0.15


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Appendix 2Shellfish Opportunities

There are two shellfish aquaculture farm leases currently available: one for a blue musselfarm site in Prince Edward Island, and another for an American oyster farm site in NewBrunswick. It is expected that the mussel farm site would reach the full capacity yield of

approximately 900,000 kilograms of mussels per year within four years, whereas theoyster farm would have an annual full capacity yield of 700,000 kilograms within five years.Operating costs would consist mainly of labour, seed mussels/oysters, site leases,expendable supplies, and maintenance of equipment.

Establishing the mussel farm would require an initial capital investment of $600,000 infacilities and equipment. Blue mussels require two to three years to reach a marketablesize. Every five years, an additional investment of $200,000 would be required to replaceworn out equipment.

The oyster farm site is smaller than the mussel farm and would require an initial capital

investment of $400,000 in facilities and equipment. American oysters require three to fouryears to reach the size and quality required to realize premium prices. Every five years, anadditional investment of $150,000 would be required to replace worn out equipment.

Approximate annual harvest volumes and operating costs (both in 000s) are as follows:

Blue Mussels: Year 1 Year 2 Year 3 Year 4 Year 5

Expected harvest volume - - 810 kg 900 kg 900 kg

Variable production costs $ 68 $ 90 $122 $135 $135

Amortization 60 60 60 60 60

Other fixed production costs 81 81 81 81 81

Selling, distribution and administration* 30 30 222 240 240

Total $239 $261 $485 $516 $516

American Oysters:

Expected harvest volume - - - 490 kg 700 kg

Variable production costs $ 53 $ 70 $ 95 $105 $105

Amortization 40 40 40 40 40

Other fixed production costs 70 70 70 70 70

Selling, distribution and administration* 30 30 60 182 234

Total $193 $210 $265 $397 $449

* Incremental (not allocated) costs; assumes general selling and administrative support prior toharvesting and selling would be provided by current AFC staff; also assumes variable selling costof 4% of revenue and variable distribution costs to local North American markets of $0.14 per kg.


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Appendix 3Genetically Engineered Salmon

INTERNAL MEMORANDUM

TOP SECRET

TO: Guy MillsFROM: Lily SternSUBJECT: Proposed Project Blue WaveDATE: June 1, 2011

Here is the summary of my proposal on Project Blue Wave. In about two years, I believewe could have a genetically altered Atlantic salmon that would have three majoradvantages over the current variety:

1. Increased efficiency in converting feed into protein, resulting in a faster growth rate.The annual yield of harvestable salmon from all four sites would increase from3,800,000 kilograms to 5,100,000 kilograms.

2. An inability to breed with wild salmon. This quality would reduce the environmentalmovements concerns about such genetic modifications.

3. Greatly increased disease resistance, resulting in lower medical and veterinary costs.

Similar techniques have been used successfully in the grain industry in recent years. Ihave made some preliminary enquiries with Canadian government agencies and havereceived favourable feedback. If we succeed in creating the first genetically engineeredfish by June 2013, we could get Canadian government approval within six months, hatchour first commercial batch of fish in January 2014, and begin harvesting our first

genetically engineered adult fish in April 2015. U.S. government approval would berequired for U.S. exports and would likely take a year longer than approval from theCanadian government.

This project will require an investment in additional research labour and direct materials of$1.2 million per year for the next two years. Assuming we can get the financing, AdamRice and I estimate that the overall net present value of this project over the next five yearsusing a discount rate of 10% will be $500,000. We also estimate that the variable cost forthe genetically engineered fish will be $1.93 per kilogram and the full cost will be $2.91 perkilogram sold once we start harvesting them in 2015.

We are on the verge of a great breakthrough. I stake my professional reputation on this. Infact, if AFC does not want to support this research, I will resign and find another sponsor.

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AquaFish_Additional Information CMA