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GULELE OIL EXTRACTION COMPANY

The owners of the Gulele Oil Extraction Company were planning an expansion of factory
facilities in Gulele 2001 order to put their business on a profitable basis. In recent years, the
operations of the factory had lost money and the owners were convinced that the addition of new
modern facilities would result in more profitable operations for the company.

The existing facilities were installed in 1994 when the factory was started. Although these
facilities were old, not well maintained, and lacked some of the more efficient features of a
modern oil extraction installation, they were in operating condition and were producing saleable
oil extraction products. The owners’ idea was that by supplementing existing facilities with a
modern installation, which would double the capacity of the factory, the company would benefit
in two ways. In their own words, they felt that:

1. " With double capacity the production cost per kilo of product would be reduced; hence;
profits would be higher."

2. "Since the new installation would be a more efficient, lower cost process that part of
production which was processed by the new installation would be even more profitable."

The owners were planning to apply for a government loan of 12 million birr to purchase the new
installation. In this connection, they had retained an outside accountant to prepare certain data to
attach to their loan application.

Background of the Company

Although the Gulele Oil extraction Company was originally established in Addis Ababa in 1994,
the present owners did not acquire the business until 1998. Prior to 1998, these owners had been
the sales agents for the company. In that year, the business had become insolvent due to the
dividends that the former owners paid to themselves. The present owners were able to buy the
shares of Gulele Oil for 30 million birr. The New owners were as follows:

Shares Invested Capital

Eng. Abraham Solomon 1,000 10,000,000

Ato Seid Ali 700 7,000,000

Ato Asfaw Kumsa 500 5,000,000

Ato Zegeye Kumsa 500 5, 000,000

Small Sharehoders ( about 15) 300 3,000,000

Total 3,000 30,000,000

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Ing. Abraham and his associates, Ato Seid and the two Kumsa brothers, comprised the group,
that had been sales agents for Gulele before acquire it. The group; purchased the entire 3000
shares of the company, but subsequently sold 300 shares to various members of their family and
friends.

After acquiring the business, Ing. Abraham assumed the position of Managing Director and
actively directed the operations of the company. While his associates also became directors of
Gulele, they were not active in the day-to-day operations of the factory, but preferred to continue
their business activities in the Markato. Among other activities they continued to act as sales
agents for the Gulele factory.

When the present owners took control of Gulele in 1998, it was an operating business with a full
staff or employees and workers, including a German chemist who was responsible for technical
matters. The present company was essentially a continuation of that business with the
substitution of Ing. Abraham as Managing Director. Shortly after taking control, the new owners
terminated; the services of the German technician on the grounds that his salary was excessive
and that his Ethiopian assistant could perform the technical functions adequately. This decision
did not result in any apparent quality problem and there continued to be a good market for
Gulele’s products.

The prior owners had apparently kept very poor, if any, accounts of the factor’s operations, since
there were no clear records of profits of prior years’ operations. In 1999, the new owners
attempted to correct this by hiring a part-time accountant who kept certain limited books of
account. Hence, 2000 was the first full year for which records were available.

Products and Production

The basic operation of the Gulele factory was to breakdown cottonseeds into the basic
components and to extract cottonseed oil and byproducts which has a commercial value. In
addition, the factory had a small soap-making operation. The main raw materials were
cottonseeds which were purchased from cotton gins during the harvest months. Beside
cottonseed, a small amount of animal fat was purchased for soap making.

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This case is based on an actual business situation in Ethiopia. Only the names, financial data and
the name of the company are fictitious.
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The primary product of the factory was cottonseed oil, which was sold in a semi-refined state to
hydrogen sating plants, where it was further processed into solid state cooking shortening and
margarine, and in a more refined state to confectionery and candy makers. There was an
excellent market for cottonseed oil in Ethiopia and oil extracting plants like Gulele have been
able to sell all they can products. In recent years, there had been a trend toward integration in the
industry whereby oil extractors had expanded into hydrogenating and in some cases, had their
own cotton gins. But there still remained a high demand for the oil produced by the small
extractors.

The by-products of the extraction process were cake, soap, linters and hulls. There was an
excellent international market for cake, which is the residue after the oil has been extracted.
Gulele cake was sold by its sales agents to German buyers at good prices. Linters, which are the
short cotton fibers adhering to the seed, were removed prior to extraction and sold to local
markets. The market for linters was fair to poor since there was an ample supply. The hulls, or
shell or the seeds, were also sold locally.

The soap produced at Gulele was basic yellow laundry soap it was molded on the floor of the
soap plan, about 10 centimeters deep, then cut into slabs and then into hand size cakes. It was
sold by the agents, unperfumed and unwrapped, through Markato outlets. The market for this
plain soap was declining and many of Guleles competitors had up-graded their soap-making
operation to produce perfumed, individually wrapped soap, similar to foreign products.

Gulele’s factory records showed the following amounts of production for oil and by-products for
the year 2000:

Product Production in 2000 (kilos)

Oil 418,000

Cake 1,765,000

Soap 225,000

Linters 180,000

Hulls 1,016,000

Total 3,604,000

The capacity of the Gulele Plant was about twice the current production, operating seven days a
week for ten months of the year (300 days) . To operate at capacity required about 25 tons of
cottonseed per day, or about 7500 tons per year. Because cottonseed oil consumption and,
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therefore, the oil extraction industry had grown more rapidly in the past ten years than the cotton
crop in Ethiopia, there was a certain amount or competition for the available seed supply.

At that time, good seeds were available in abundance only in the months of January, February
and March when the cotton crop was harvested and ginned. Those oil extractors who were also
cotton ginners has an advantage in assuring themselves a good supply of seeds. Otherwise, it
was wise to purchase the year’s requirements during these months, because by summer and
spring prices increased apprecizbly. By late summer or early spring, the supply was usually
exhausted and many oil extracting plants were unable to operate until the new crop arrived.

Data Attached to the Loan Application

In submitting their application for the 12 million birr loan to expand and modernize the Gulele
factory, the owners found that certain production and financial data were required which they
were not entirely sure how to prepare in the form of the application. At the suggestion of the
loan Officials, they engaged an outside accountant, recommended by the bank as reliable, to
prepare such information.

The data prepared by the accountant and attached to the application are shown in Exhibits I, II,
III and IV.

Exhibit I
Gulele Oil extraction Company
Cost of Proposed Expansion
Equipment Installed Cost (Birr)
Oil Press and Associated Equipment 3,942,00

Power Unit 2,677,500

Boiler 2,000,000

Transport Equipment 1,000,000

De-linter Installation 1,000,000

Other Process Equipment 1,250,000

Spare Parts 386,900

Total 12,256,400
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Exhibit II
Gulele Oil Extraction Company
A. Production and Capacity Data
Production Per Year in Kilos

Product 2000 2001 Present Capacity Proposed Capacity

Oil 418,000 470,900 900,000 1,800,000

Cake 1,765,000 1,942,200 3,225,000 6,450,000

Soap 225,000 249,900 420,000 840,000

Linters 180,000 278,400 262,500 525,000

Hulls 1,016,000 1,527,000 2,527,000 4,950,000

Total 3,604,000 4,368,400 7,282,500 14,565,000

Percent
Present
Capacity 50% 60% 100% 200%

B. Production Ratio by Product

Ration of Production
to Present Capacity

Product 2000 2001

Oil 47% 53%

Cake 55% 60%
Soap 54% 59%
Linters 69% 68%
Hulls 41% 62%
Total 50% 60%
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Exhibit III
Gulele Oil Extraction Company
Comparative Income and Expense Statement

Sale Revenue Year 1339 (birr) Present (Birr) Estimated for Capacity
Production Propose (Birr)
Sales of Products
Oil 17,120,000 32,400,000 64,800,000
Cake 7,270,000 14,512,000 29,025,000
Soap 4,260,000 7,560,000 15,120,000
Linters 1,440,000 2,362,500 4,725,000
Hulls 1,780,000 2,475,000 4,950,000
Total 37,870,000 59,310,000 118,620,000
Other Sales 130,700 300,000 600,000
Total Sales Revenue 32,000,000 59,610,000 119,220,000

Cost of Goods Sold

Seeds 32,677,900 45,000,000 90,000,000
Soap Fat 2,100,000 4,220,000
Salaries and Wages 2,676,900 2,100,000 3,000,000
Worker Insurance 243,400 156,000 208,000
Containers 100,000 200,000
Chemicals 1,060,400 1, 139,250 2,278,500
Fuel 1, 200,000 2,400,000

Estimated for capacity Production

Cost of Goods Sold Year 2000 (Birr) Present (Birr) Proposed

(Birr)

Maintenance 153,600 200,000 300,000

Transport 155,500 240,000 480,000
Property Insurance 240,000 340,000
Bonuses 120,000 120,000
Other expenses 120,000 120,000
Depreciation 2,000,000 2,000,000 3,000,000
Total manufacturing 38,967,700 54,715,250 106,706,500
Administrative and Selling Exp. 246,300 300,000 300,000
Total Operating Expense 39,214,000 55,015,250 107,066,500
Operating Profit (Loss) 7,214,000 4,594,750 12,213,500
Interest Expense 1,800,000 3,600,000 8,160,000
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Net Profit (Loss) (9,013,300) 994,750 4,053,500

Short-term Markato borrowing at 18% to purchase annual seed requirements during ginning
season.
Includes short-term borrowing at 18% for seed purchases plus interest on 12 million Birr at 8%

Gulele Oil Extraction Company Balance Sheet End of 2000

Assets Birr

Current Assets
Cash 17,536
Receivables 1,772,181
Inventories 3,125,269
4,914,986

Fixed Assets
Land at Cost 1,149,225
Increase in Value 7,450,775
Current A;;raised Value 8,600,000

Machinery and Equipment Cost 32,543,108

Less Reserve-Depreciation 2,000,000
Depreciated Value 30,543,108
Total Assets 44,058,094

Liabilities and Shareholders’ Equity

Current Liabilities

Note Payable 7,331,285

Accounts Payable 2,650,595
9,981,880

Advances by Shareholders
Convertible to Capital Stock
4,802,500

Shareholders’ Equity
Capital Stock 30,000,000
Net Issued 30,000,000
Capital Surplus (see note) 7,450,775
Accumulated (losses) 8,177,061
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Total Shareholders’ Equity 29,273,714

Total Liabilities and Shareholders’ Equity 44,058,094

Note:
Capital Surplus of 7, 450,775 Birr was created by increasing the book value of the
premises to its estimated current value. This for credit purposes only.