Milk and Money Harvard Case Solution & Analysis

Background

Gerard is the owner of third-generation owner of California dairy farm. The financial success of the dairy farm depends upon the cost of the production and prevailing prices of dairy product in the market. Unpredictable price fluctuation in the prices of the dairy product poses risk to the dairy farm industry. The majority of dairy business is family owned and price variation will not be favorable in their family business interest if prices are downward or declining trend.

For the protection of prices of the dairy product, the use of alternative investments can be used for the protection of the prices such as option on dairy products. Put option can be used to hedge or insure the selling price and it will allow family business to lock in the price and can predict cash flow and selling price very accurately and with precise detail. Dairy farming’s profitability and long term sustainability depends upon the quality of product, cost of product and the productivity. It is not always true that increased in productivity brings more profit often due to fact decline in the commodities prices due to different reasons such as local and global demand, taste of consumers, preferences and other factors as well affect the production and consumption pattern.

Problem identification

Multiple problems can be identified from the case such as rising cost of production of milk and unpredictable price of selling dairy products. The pricing of the dairy products was heavily regulated in the other sates of USA however, in the Chicago prices of dairy products are determined by local and international supply and demand of the dairy products.

Raising cost of animal foods and others is also creating problems for the family owned dairy owners to earn sufficient amount of income. Dairy’s cost by size in Table 2 depicts that less than 50 owners of cow are generating more than negative return of 12.22%. On the other hand, more than 999 are generating a net return of 2.95%, which suggest that on the small scale operating a dairy farm with less than 50 cows will be loss making while starting with significant high amount of investment and start farm with more than 999 cows will yield a good return of net profit.

Above all there is a huge problem with the pool price, which in reality, is difficult to predict. Mailbox price between 2005 and 2007 ranged from $10.16 to $19.98. As far as raising cost is concerned, this price is thought to be unacceptable and should be raised so that owners and investor can generate good return on their investments.

Raising operating cost is also the cause of concern as this cost cannot be passed to the customers. Gerard’s cost of production is $12 and if prices come to $12 or drop below $12 than Gerard will be in position to making huge losses. Prices of animal food, labor cost and othercost that is increasing due to inflation is unable to pass to the customers

Possible alternate solution

A possible alternative is to do nothing, and keep the thing as they are working. If they are facing high prices, then they will affect the whole dairy industry and not only Gerard.

Another alternative is to sell high volume of dairy products only when prices are high, in this way a higher rate can be yielded from the buyer and by selling lower amount of dairy products in the period when prices are low.Milk and Money Case Solution

Another option is the unpredictable, volatile and dynamic environment where price cannot be predicted with accuracy, the use of hedging instruments can be used to protect the business from the unforeseen events or lock in the price of the dairy products in the present. Gerard can buy put option on the different dairy products and can set the min or floor price of the product. In this way, Gerard can insure the selling price of its dairy products and by buying put option by paying the premium. The premium on the put options on vary and based on time to maturity and strike price.

The options on the dairy product give the holder an option to exercise the option or not, the decision whether to exercise the options will depend whether option is in the money or out of money. If the option is on the money which means that from the strike price the price in spot or open market have decline and if option is out of money can be interpreted as prices of dairy product have not decline from the strike price of the options.(Hull)................

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