King Follett Foods produces premium tofu for the U.S. market. Sales are growing rapidly in the health-conscious United States, and King Follett expects sales in 2009 to be 30% more than sales in 2008.

A key ingredient in making tofu is soybeans. During 2008, King Follett used approximately 10,000 bushels of soybeans per month. The cost of a bushel of soybeans has varied from a high of $9.00 to a low of $7.00.

To stabilize its production cost, in 2008 King Follett initiated a program of using forward contracts to lock in the cost of soybean purchases in advance. The three employees in the finance department who oversee this program are starting to get a pretty good feel for the way prices move in the soybean market. As of the end of 2008, these employees have purchased the following forward contracts for the first three months of 2009:

In each case, if the market price on the first day of the month is more than the forward price, King Follett collects the difference (multiplied by the number of bushels in the contract). In 2008, the forward contract purchase program netted a profit of $12,000 over and above the offsetting cost of goods sold increase from the effect of price increases on the cost of soybeans.
Comment on whether the three employees in the finance department have structured the forward contracts to properly hedge the risk of fluctuations in soybeanprices.

Transcribed Image Text:

Amount in Bushels Forward Price per Bushel January 2009 February 2009 March 2009 20,000 30,000 30,000 $8.00 8.50 8.60