A case study involving the purchase of a farm and subsequent crop production of tobacco and paprika over a ten-year operation period in a developing country is presented. Initially a base estimate is prepared and a risk analysis performed. Risks are then mitigated and the risk analysis is performed again. The results of the risk analysis can then be used as part of the business plan.

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A case study involving the purchase of a farm and subsequent crop production of tobacco and paprika over a ten-year operation period in a developing country is presented. Initially a base estimate is prepared and a risk analysis performed. Risks are then mitigated and the risk analysis is performed again. The results of the risk analysis can then be used as part of the business plan.

All rights reserved. Introduction In this paper risk management techniques are applied to a hypothetical farm investment in a developing country. As project management concentrates on a project, rstly the authors consider the term project. In the hypothetical case study the appraisal period is 11 yr, the end of the appraisal period can be dened as the end of the undertakings life span.

E-mail address: pwmorris netcomuk. In this case study the production of tobacco and paprika can be dened as a project on its own, as well as the construction of infrastructure such as housing for farm workers, clinic, school, tobacco barns and the installation of an irrigation system.

Also, the installation of a computer system and the subsequent training of sta can be dened as a project. The resources used to carry out projects are people, money, equipment and time. The project parameters time, cost and performance quality are specied in the planning phase of the project and form the base for control during the implementation phase. CASPAR is normally used to appraise construction projects such as the Mersey barrage, the Severn tidal power scheme, industrial plants, toll roads, bridges and privately nanced prisons.

The CASPAR programme is intended for use at the appraisal stage of the project cycle where project denition is low and time scale is long. This computer software facilitates the preparation of sensitivity analysis plots of cumulative frequency distributions for time and cost. This programme also enables the user to make small changes to the model without signicant calculation of the data.

The programme can be used for three main purposes:. The software simulates the interaction between time, resources, cost and revenue over the entire project life.

A network of interlinking activities each allocated a cost centre is created in a data le. The resources are either quantity or cost based and project related. The computer generates the cash ow from which nancial parameters, such as the IRR, NPV, payback period, discounted payback period, net cash balance, maximum cash lock up, maximum discounted cash lock up, maximum investment, net return, discounted net return are obtained.

The software can also simulate the eects of risks and produce sensitivity analysis of individual risks or combine the eects of project risk in a probabilistic analysis utilising a Monte Carlo simulation technique. Sensitivity analysis Sensitivity analysis is performed by changing the values of independent risk variables to predict the economic criteria of the project.

A sensitivity diagram can be produced from the results obtained from the CASPAR programme, which identies the most sensitive risk variables and the relative importance of each variable. The range of percentage changes in each variable reect the uncertainty associated with each variable. The main limitation of the sensitivity analysis is that no indication of the likely probability of occur-.

Another shortcoming is the fact that each variable is considered independently. In reality the management normally wants to know the result of the combined eect of changes of two or more variables because some combination of the variables considered independently during a sensitivity analysis will occur. The above mentioned limitations are overcome by probability analysis which can specify a probability frequency distribution for each risk and for the project.

It can also consider situations where a number of variables can be varied at the same time. The frequency of occurrence of a particular value of any one of the variables is determined by dening the probability distribution to be applied across the given range of values.

The results are shown as frequency and cumulative frequency diagrams. The allocation of probabilities of occurrence to each risk requires the denition of ranges for each risk [3].

The denition of these ranges is normally subjective especially if no historical data is available and therefore project members who are responsible for the original estimates should be involved in this exercise. The steps of a probability analysis in the CASPAR programme are: a assess the ranges for the variables being considered and determine the probability distribution most suited to each variable; b select values for the risk variables by the Monte Carlo method; c run a deterministic analysis using the combinations of values selected; d repeat steps b and c a number of times; the resulting collection of outcomes is then arranged in sorted order to form a probability distribution of the result.

The accuracy of the nal distribution depends on the number of repetitions, or iterations, usually iterations provides sucient accuracy. The basic model The appraisal period for the case study spans 11 yr. The rst year is the period designated phase 1.

During this year the prepurchase preparation is done. Tasks such as the prefeasibility study, discussions with experts, nancial institutions and local authorities,. The production stage, which spans 10 yr, starts after phase 1 in the 2nd yr and designated phase , with each production phase equalling 1 yr. As the case study deals with an agricultural project the production tasks are the same every year as agricultural projects typically follow the same cycle each year unlike construction projects where tasks in the sequence are normally project denition, project conception, project design, construction, commission and operation.

The agricultural production cycle is inuenced by the weather periods those being the dry season from May to October and the wet season from November to April. Therefore, the production stage must be divided into 10 time periods corresponding to the nancial years. For purpose of modelling with CASPAR the dened activities elements of a project are not tasks but other elements of the project. In the production stage 1 yr has eight activities: tobacco direct costs, paprika direct costs, interest payments, indirect costs of tobacco and paprika production, tobacco revenue, paprika revenue, loan receipts and earned interest.

Exceptions are in phase 2 and phase , as the production of paprika only starts in the second production year phase 3 , phase 2 has only six activities no paprika direct costs and no paprika revenue. Furthermore, from phase 7 to 11 there are no loan receipts these phases consist of only seven activities each. Therefore, the number of activities from phase 1 to 11 is Investment in infrastructure and machinery and equipment over a period of 10 yr is also included.

The highest investment is planned for yr 2 and 3 for building a storage extension for the storage of tobacco and paprika, the installation of an irrigation scheme, building tobacco barns and grading shed, construction of houses for farm employees and school extension for farm workers children, the drilling of a borehole and the installation of a transformer house. Debt service for the investments are planned to be nanced by loans until yr 5.

From yr 6 onwards the investments are planned to be nanced by the accumu-. The calculated IRR is The cash pay back time CPBT is the length of time required to recoup the money invested in a capital project.

The time the project requires to pay back the initial investment for purchasing the farm and the planned investments in machinery, equipment and infrastructure and other costs like fees and expenses incurred in phase 1 and running costs of the production phases is 5.

The next step is the risk analysis consisting of the sensitivity analysis and probability analysis, which quanties the eects of the major risks identied on the economic parameters.

Sensitivity analysis The 11 risks identied below are typical risks in the principal areas of agricultural projects, which are sensitive to change. Risks like tobacco curing management and destruction of tobacco by hail are specic to tobacco production [4]. There are 11 identied risks:. Probability analysis The results of the probability analysis are shown in Figs. IRR The cumulative probability distribution diagram in Fig.

Compared with the original prediction of an IRR of Therefore, the project appears to be very risky based on the ranges used in the analysis. NPV The cumulative probability distribution diagram in Fig. The results of the probability analysis using the NPV as an economic parameter conrm the results of the probability analysis for the economic parameter IRR, indicating that the project seems to be very risky. Risk mitigation Mitigation of the identied risks is now carried out.

A result of this risk mitigation exercise will be that the ranges of the variables whose risks were mitigated will be reduced. Then new results will be calculated and depicted in new diagrams after sensitivity and probability analyses.

Risk mitigation can be done for all the identied risks:. The negative risk of tobacco production management can be reduced by an extremely thorough search and recruitment drive for a competent and reliable farm manager. The recruited farm manager must make sure that project management tools like quality management, risk management, human resource management, nance and production management are used and proper planning and implementation of plans and monitoring takes place.

The identication of tobacco curing management as a signicant risk requires that special emphasis is made on this activity. The potential of the tobacco leaf which it possessed at the time of reaping cannot be improved by curing.

Curing alters the leaf into a dierent state by yellowing colouring and drying. Bad curing can spoil a potentially good leaf. Therefore only negative risks are allocated to curing management.

The negative range can be reduced by risk mitigation measures, good quality management with a detailed quality plan and work instructions will help. The farm manager must train and closely supervise the people who are working in the curing section. The manager should gather as much knowledge about tobacco curing as possible by consulting experts in tobacco curing. The only risk which can be totally mitigated is the negative risk of destruction of tobacco by hail. The tobacco farmer can transfer this risk by buying a hail insurance.

Typical premiums for hail insurance is approximately 2. The compensation covers the damage of the crop by hail and, together with the farmers salvage operations, should retrieve the cost of production for the next growing season. The premium for the tobacco hail insurance is already included in the cost of production calculation. The negative risks of weather can be reduced by the construction of an irrigation system to mitigate the impact of droughts.

In the case of heavy rains risk. The costs of these mitigation measures are included in the cost of production. The main reason for installing an irrigation system is the addition of a second crop which is planted earlier.

The supplementary irrigation of tobacco in dry years should be done with equipment which is normally used for the early crop. Investment in irrigation only for the purpose of eventual supplementary irrigation in drought years is not protable whereas the addition of a second early crop is the major advantage of irrigation.

Therefore, the use of an irrigation system for drought impact mitigation is a welcome side eect of the investment in an irrigation system which will be primarily installed in order to grow a second crop. The negative and positive ranges of the variables tobacco output and paprika output will be equally reduced by a more conservative approach concerning the planned output. The farmer does not want to expand too quickly and risk that the production management gets out of hand which then would have the consequence of not only lower crop quality but also lower crop output.

For the risk of change in interest rates both negative and positive ranges will be equally reduced by negotiating loans and deposits with xed rates of interest. Loans with xed rates of interest are preferable as the interest to be paid is known and therefore the risk of higher interest payments caused by rising interest rates is avoided. Loans which cannot be negotiated with xed interest rates will be arranged with nancial institutions in foreign countries which are less volatile to changes in interest rates.

The debt service could be paid from a foreign exchange account [5].


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