CASE STUDY Stay fresh, a manufacturer of refrigerators in India, has two plants- one in Mumbai and the other

in Chennai. Each plant has a capacity of 300,000 units. The two plants serve the entire country, which is divided into four regional markets: the North, with a demand of 100,000 units; the West, with a demand of 150,000 units; the South, with a demand of 1,50,000 units; and the East, with a demand of 50,000 units. Two other potential sites for plants include Delhi and Kolkata. The variable production and transport costs (in thousands of rupees; 1 U.S dollar is worth about 45 rupees) per refrigerator from each potential production site to each market are as shown in Table 5.12.

Table 5.12
To From Up to 150K Above 150K but less than 300K Delhi 250 230 North Kolkata 258 240 South Delhi 270 250 Kolkata 260 245 East Delhi 255 240 Kolkata 250 230 West Delhi 250 238 Kolkata 270 250

Note:

The price indicated above is the unit price in Dollars.

Stay Fresh is anticipating a compounded growth in demand of 20 percent per year for the next five years and must plan its network investment decisions. Demand is anticipated to stabilize after five years of growth. Capacity can be added in increments of either 150,000 or 300,000 units. Adding 150,000 units of capacity incurs a one- time cost of 2 billion rupees. Whereas adding 300,000 units of capacity incurs a one- time cost of 3.4 billion rupees. Assume that Stay Fresh plans to meet all demand (prices are sufficiently high) and that capacity for each year must be in place by the beginning of the year. Also assume that the cost for the fifth year will continue for the next 10 years, that is years 6 to 15. The problem can now be solved for different discount factors. To begin with assume a discount factor of 0.2, that is, 1 rupee spent next year is worth 1-0.2= 0.8 rupee this year. Questions:

Q1. Q2. Q3. Q4

How should the production network for the company evolve over the next five years? How does your answer change if the anticipated growth is 15 %? 25 %? How does your decision change for a discount factor of 0.25? 0.15? What investment strategy do you recommend for the company?

1. The production network for the company evolution over the next five years

The case study says that the growth in demand is expected to be 20 percent per year for the next five years and Stay Fresh plans to meet this demand. The table below shows the demand schedule for the next 5 years and the demand is anticipated to stabilize after the 5 years of growth. Year 0 1 2 3 4 5 South(S) 150,000 180,000 216,000 259,200 311,040 373,248 West(W) 150,000 180,000 216,000 259,200 311,040 373,248 North(N) 100,000 120,000 144,000 172,800 207,360 248,832 East(E) 50,000 60,000 72,000 86,400 103,680 124,416 Total Demand (S+W+N+E) 450,000 540,000 648,000 777,600 933,120 11,19,744

Stay fresh already has an installed capacity of 600,000 units (300,000 in Mumbai and 300,00 in Chennai). Total planned capacity addition for the next 5 years is 5, 19,744 units (11, 19,744 - 600,000). In order to match to this demand, Stay Fresh can increase their production capacity by either 300,000 units or 150,000 units in Delhi and/or Kolkata. Thus, Stay Fresh will need an additional capacity of 600,000 units in the next 5 years. Now, capacity addition of 150,000 units incurs a one time cost of Rs. 2 Billion and that of 300,000 units costs Rs. 3.4 Billion as per the given information. We have to assume a discount rate of 0.2. As we do not have the information about the cash inflows or revenue, it is not possible to find out the profitability of the investment. However, using the NPV (Net Present Value) concept we can find out the investment which costs least to the company or least capital outflow. We will also have to make sure that the capacity for each year is in place before the beginning of the year. To start with we have to analyze various scenarios in which these capacity additions can be made. We will discuss the profitability of the location later.
1. Adding 150,000 units every year,

NPV= 2/ (1.2) +2/ (1.2) (1.2) +2/ (1.2) (1.2) (1.2) +2/ (1.2) (1.2) (1.2) (1.2) = (5.177) Billion Rs.

2. Adding 600,000 (2*300,000) in the first year, NPV= 2*3.4/1.2= (5.67) Billion Rs. 3. Adding 300,000 units in first and the third year, NPV= 3.4/ (1.2) +3.4 / (1.2) (1.2) = (4.8) Billion Rs. Thus, it is clear that the third option has the least cost outflow or highest NPV.

We now know that we have to add 300,000 units in the first and the third year, but it is important to find out which location will be more economical in terms of transportation cost. The capacity addition is to be done in either Delhi and/or Kolkata. As per the demand schedule Delhi has a higher demand than Kolkata so there could be two scenarios here, adding both these capacities of 300,000 units in Delhi in the first and the third year or we can add first 300,000 units in Delhi and the next 300,000 units in Kolkata.

To From Up to 150K Above 150K but less than 300K Delhi 250 230

North Kolkat a 258 240

South Delhi 270 250 Kolkat a 260 245

East Delhi 255 240 Kolkat a 250 230

West Delhi 250 238 Kolkat a 270 250

As the cost for the fifth year will continue for the next 10 years, we will find out transportation cost for the 5 th year in both of these scenarios.

1. Capacity addition of 600,000 (300,000 in first and 300,000 in second year) in Delhi. Then transportation cost as per the table will be, (73248*270)+ (73248*250) + (124416*255) + (248832*230) = 5.72 Billion Rs. 2. Capacity addition of 300,000 in Delhi and 300,000 in Kolkata. Then, the transportation cost would be, (73248*260)+ (73248*250) + (124416*250) + (248832*230) = 5.66 Billion Rs. The second option is clearly more economical.

Thus, the production network of Stay Fresh will be most economical if they install a capacity of 300,000 units in the first year in Delhi and subsequently another 300,000 unit capacity in the third year in Kolkata.

2. Change if the anticipated growth is 15 %? 25 % a. When the anticipated yearly growth is 15%.

The case study says that the growth in demand is expected to be 15 percent per year for the next five years and Stay Fresh plans to meet this demand. The table below shows the demand schedule for the next 5 years and the demand is anticipated to stabilize after the 5 years of growth. Year 0 1 2 3 4 5 South(S) 150,000 172,500 198,375 228,132 262,352 301,705 West(W) 150,000 172,500 198,375 228,132 262,352 301,705 North(N) 100,000 115,000 132,250 152,088 174,902 201,138 East(E) 50,000 57,500 66,125 76,044 87,451 100,569 Total Demand (S+W+N+E) 450,000 517,500 595,485 684,396 787,057 905,117

Stay fresh already has an installed capacity of 600,000 units (300,000 in Mumbai and 300,00 in Chennai). Total planned capacity addition for the next 5 years is 305,117 units (905,117 - 600,000). In order to match to this

demand, Stay Fresh can increase their production capacity by either 300,000 units or 150,000 units in Delhi and/or Kolkata. Thus, Stay Fresh will need an additional capacity of 600,000 units in the next 5 years. Now, capacity addition of 150,000 units incurs a one time cost of Rs. 2 Billion and that of 300,000 units costs Rs. 3.4 Billion as per the given information. We have to assume a discount rate of 0.2. As we do not have the information about the cash inflows or revenue, it is not possible to find out the profitability of the investment. However, using the NPV (Net Present Value) concept we can find out the investment which costs least to the company or least capital outflow. We will also have to make sure that the capacity for each year is in place before the beginning of the year. To start with we have to analyze various scenarios in which these capacity additions can be made. We will discuss the profitability of the location later. 1. Adding 150,000 units every year, NPV= 2/ (1.2) +2/ (1.2) (1.2) +2/ (1.2) (1.2) (1.2) +2/ (1.2) (1.2) (1.2) (1.2) = (5.177) Billion Rs. 2. Adding 600,000 (2*300,000) in the first year, NPV= 2*3.4/1.2= (5.67) Billion Rs. 3. Adding 300,000 units in first and the third year, NPV= 3.4/ (1.2) +3.4 / (1.2) (1.2) = (4.8) Billion Rs.

Thus, it is clear that the third option has the least cost outflow or highest NPV. We now know that we have to add 300,000 units in the first and the third year, but it is important to find out which location will be more economical in terms of transportation cost. The capacity addition is to be done in either Delhi and/or Kolkata. As per the demand schedule Delhi has a higher demand than Kolkata so there could be two scenarios here, adding both these capacities of 300,000 units in Delhi in the first and the third year or we can add first 300,000 units in Delhi and the next 300,000 units in Kolkata.
To From Up to 150K Above 150K but less than 300K Delhi 250 230 North Kolkat a 258 240 South Delhi 270 250 Kolkat a 260 245 East Delhi 255 240 Kolkat a 250 230 West Delhi 250 238 Kolkat a 270 250

As the cost for the fifth year will continue for the next 10 years, we will find out transportation cost for the 5 th year in both of these scenarios.

1. Capacity addition of 600,000 (300,000 in first and 300,000 in second year) in Delhi. Then transportation cost as per the table will be, (1705*270)+ (1705*250) + (100,569*255) + (201,138*230) = Billion Rs. 2. Capacity addition of 300,000 in Delhi and 300,000 in Kolkata. Then, the transportation cost would be, (1705*260)+ (1705*250) + (100,569*250) + (201,138*230) = Billion Rs. The second option is clearly more economical.

Thus, the production network of Stay Fresh will be most economical if they install a capacity of 300,000 units in the first year in Delhi and subsequently another 300,000 unit capacity in the third year in Kolkata.

b. When the anticipated yearly growth is 25%. The case study says that the growth in demand is expected to be 25 percent per year for the next five years and Stay Fresh plans to meet this demand. The table below shows the demand schedule for the next 5 years and the demand is anticipated to stabilize after the 5 years of growth. Year 0 1 2 3 South(S) 150,000 187,500 234,375 292,969 West(W) 150,000 187,500 234,375 292,969 North(N) 100,000 125,000 156,250 195,313 East(E) 50,000 62,500 78,125 97,657 Total Demand (S+W+N+E) 450,000 562,500 703,125 878,908

4 5

366,212 457,765

366,212 457,765

244,142 305,178

122,072 152,590

10,98,638 13,73,298

Stay fresh already has an installed capacity of 600,000 units (300,000 in Mumbai and 300,00 in Chennai). Total planned capacity addition for the next 5 years is 773,298 units (13,73298 - 600,000). In order to match to this demand, Stay Fresh can increase their production capacity by either 300,000 units or 150,000 units in Delhi and/or Kolkata. Thus, Stay Fresh will need an additional capacity of 600,000 units in the next 5 years. Now, capacity addition of 150,000 units incurs a one time cost of Rs. 2 Billion and that of 300,000 units costs Rs. 3.4 Billion as per the given information. We have to assume a discount rate of 0.2. As we do not have the information about the cash inflows or revenue, it is not possible to find out the profitability of the investment. However, using the NPV (Net Present Value) concept we can find out the investment which costs least to the company or least capital outflow. We will also have to make sure that the capacity for each year is in place before the beginning of the year. To start with we have to analyze various scenarios in which these capacity additions can be made. We will discuss the profitability of the location later. 1. Adding 150,000 units every year, NPV= 2/ (1.2) +2/ (1.2) (1.2) +2/ (1.2) (1.2) (1.2) +2/ (1.2) (1.2) (1.2) (1.2) = (5.177) Billion Rs. 2. Adding 600,000 (2*300,000) in the first year, NPV= 2*3.4/1.2= (5.67) Billion Rs. 3. Adding 300,000 units in first and the third year, NPV= 3.4/ (1.2) +3.4 / (1.2) (1.2) = (4.8) Billion Rs.

Thus, it is clear that the third option has the least cost outflow or highest NPV.

We now know that we have to add 300,000 units in the first and the third year, but it is important to find out which location will be more economical in terms of transportation cost. The capacity addition is to be done in either Delhi and/or Kolkata. As per the demand schedule Delhi has a higher demand than Kolkata so there could be two scenarios here, adding both these capacities of 300,000 units in Delhi in the first and the third year or we can add first 300,000 units in Delhi and the next 300,000 units in Kolkata.

To From Up to 150K Above 150K but less than 300K Delhi 250 230

North Kolkat a 258 240

South Delhi 270 250 Kolkat a 260 245

East Delhi 255 240 Kolkat a 250 230

West Delhi 250 238 Kolkat a 270 250

As the cost for the fifth year will continue for the next 10 years, we will find out transportation cost for the 5 th year in both of these scenarios.

1. Capacity addition of 600,000 (300,000 in first and 300,000 in second year) in Delhi. Then transportation cost as per the table will be, (157,765*270)+ (157765*250) + (152,590*255) + (5,178*230) = Billion Rs. 2. Capacity addition of 300,000 in Delhi and 300,000 in Kolkata. Then, the transportation cost would be, (157,765*260)+ (157765*250) + (152,590*250) + (5,178*230) = Billion Rs. The second option is clearly more economical.

Thus, the production network of Stay Fresh will be most economical if they install a capacity of 300,000 units in the first year in Delhi and subsequently another 300,000 unit capacity in the third year in Kolkata.

3. Decision change when the discount factor changes to 0.25 or 0.15?

In this case study we have assumed a discount rate of 0.2 or 20%. Now, in this case we have used discounted cash flow technique of investment appraisal which involves calculation of the present value of all the cash flows associated with a project. However, in this case we are not aware of the inflows; we only have information about the cash outflows. Thus, we have used the

Net Present Value concept to find out the investment strategy which would cost least instead of using it for investment appraisal. Net Present Value can be interpreted as, NPV> 0: project earns more than the discount rate. NPV< 0: project earns less than the discount rate. NPV= 0: project earns the same as the discount rate. As in this case we have only compared the cash outflows instead of appraising it, change in discount rate to 0.25 or 0.15 would not change our strategy or decision.

4. What investment strategy do you recommend for the company?

Investment strategy

There is no universal investment strategy for deciding which one of the alternatives is the best. Sometimes, a choice can be obvious, and at other times not so clear, depending on the companys circumstances such as: Whether capital is available or whether it needs to be borrowed The ability to pay rate of interest General Liquidity Quality of market research and demand forecast Vision and Goal of the company Uncertainty of estimated flows All other factors which are part of the Value Chain So, a generic strategy would not work for Stay Fresh. However, we have seen in this case that the most significant thing for this company is the transportation charge. It is seen that the yearly transportation charge in some of the questions discussed above is more than the total installation charges of the project. When we were preparing the demand schedule for various anticipated growth rate of 20%, 15% and 25%, we increased the capacity only in Delhi and

Kolkata. Thus, it is imperative for this company to install more capacity in relevant zones as per the demand schedule to reduce the transportation charges. We have used the concept of Net Present Value to find out the investment strategy in this case. However, we do not know if the project is profitable as the value of cash inflows or revenue wasnt available. It is seen that some of the locations have idle capacity just to meet little extra demand. So, we would need some more information to precisely comment on the financial feasibility of this project.