Zhengzhou University

School of Management Engineering

Electronic Commerce

Supply Chain Management

Exercise question of chapter 5

Master Degree Student: Sabirzianov Azat

Student’s ID Number: 201912302050009

2020 year
6. StayFresh, 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 150,000 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 65 rupees) per refrigerator from each potential production site to each market are as
shown in Table 5.12
Table 5.12

North East West South

Chennai 20 19 17 15

Delhi 15 18 17 20

Kolkata 18 15 20 19

Mumbai 17 20 15 17

StayFresh 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
StayFresh 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:
a. How should the production network for the company evolve over the next five years?
b. How does your answer change if the anticipated growth is 15 percent? 25 percent?
c. How does your decision change for a discount factor of 0.25? 0.15?
d. What investment strategy do you recommend for the company?
Answers:
(a) Development of the company's production network over the next five years
The case study says that demand growth is most likely expected to be around 20 percent per year
over the next five years, and plans to meet this demand for StayFresh will remain.
 Total
Year South(S) West(W) North(N) East(E) Demand
(S+W+N+E)

0 150,000 150,000 100,000 50,000 450,000

1 180,000 180,000 120,000 60,000 540,000

2 216,000 216,000 144,000 72,000 648,000

3 259,200 259,200 172,800 86,400 777,600

4 311,040 311,040 207,360 103,680 933,120

5 373,248 373,248 248,832 124,416 1,119,744

Stayfresh already has an installed capacity of 600,000 units (300,000 in Mumbai and 300,000 in
Chennai). The total planned capacity increase for the next 5 years is 519,744 units (1,119,744 –
600,000). To meet this demand, Stayfresh must increase its production capacity by either
300,000 units or 150,000 units in Delhi and/or Kolkata. As a result, Stayfresh will require an
additional capacity of 600,000 units for the next 5 years. So adding a capacity of 150,000 units
entails a one-time cost of Rs. 2 billion and that of 300,000 units is worth Rs. 3,4 billion
according to the information provided. We should note that the discount rate is 0.2. Since we do
not have data on cash inflows or revenue, it is impossible to determine the profitability of
investments. However, using the concept of NPV (Net Present Value), we can determine the
investments that cost the least to the company or the least outflow of capital. We will also need
to make sure that the potential for each year is created before the beginning of this year. First, we
need to examine the various scenarios in which these additional capacities can be used.
1. The addition of 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. The addition of 600,000 (2*300,000) in the first year,
NPV= 2 * 3.4 / 1.2= 5.67 Billion Rs.
3. The addition of 300,000 units in the first and third years,
NPV= 3.4 / 1.2 + 3.4 / (1.2 * 1.2 * 1.2) = 4.8 Billion Rs.
It turns out that the third option has the lowest outflow of costs or the highest NPV. We found
that we need to add 300,000 units in the first and third years, but it is important to determine
which location will be more economical in terms of transportation costs. The capacity addition
should be done either in Delhi or Kolkata. According to demand indicators, Delhi has a higher
demand than Kolkata, so there can be two event outcomes here, adding both of these capacities
of 300,000 units in Delhi in the first and third year, or adding the first 300,000 units in Delhi and
the next 300,000 units in Kolkata.

North South East West

To

From Delhi Kolkata Delhi Kolkata Delhi Kolkata Delhi Kolkata

Up to
250 258 270 260 255 250 250 270
150K

Above
150K
but less 230 240 250 245 240 230 238 250
than
300K
Due to the fact that the cost for the fifth year will continue for the next 10 years, we get the cost
of transportation for the 5th year in both of these events.

1. The addition of 600,000 (300,000 in the first and 300,000 in the second year) in Delhi. We get
that the cost of transportation according to the table will be,

73,248 * 270 + 73,248 * 250 + 124,416 * 255 + 248,832 * 230 = 5.72 Billion Rs.

2. The addition of 300,000 in Delhi and 300,000 in Kolkata. We get that the cost of
transportation will be,

73,248 * 260 + 73,248 * 250+ 124,416 * 250 + 248,832 * 230 = 5.66 Billion Rs.

The second option is more economical. It turns out that the Stayfresh production network will be
most economical if they make a capacity of 300,000 units in the first year in Delhi, and then
another 300,000 units in the third year in Kolkata.

b) What will be the results if the expected growth is 15 %? 25 %

I - When the expected annual growth is 15%.

The case study says that demand growth is expected to be 15 percent a year over the next five
years, and Stayfresh plans to meet this demand. The table below shows demand indicators for the
next 5 years, and it is assumed that demand will stabilize after 5 years of growth.
 Total
Year South(S) West(W) North(N) East(E) Demand
(S+W+N+E)

0 150,000 150,000 100,000 50,000 450,000

1 172,500 172,500 115,000 57,500 517,500

2 198,375 198,375 132,250 66,125 595,485

3 228,132 228,132 152,088 76,044 684,396

4 262,352 262,352 174,902 87,451 787,057

5 301,705 301,705 201,138 100,569 905,117

Stayfresh has an installed capacity of 600,000 units (300,000 in Mumbai and 300,000 in
Chennai). The total planned capacity increase for the next 5 years will be 305117 units (905,117
– 600,000). To meet this demand, Stayfresh can increase its production capacity by either
300,000 units or 150,000 units in Delhi and/or Kolkata. Thus, Stayfresh requires an additional
capacity of 600,000 units in the next 5 years. Now adding capacity of 150,000 units entails a
one-time cost of Rs. 2 billion and that of 300,000 units is worth Rs. 3,4 billion according to the
information provided. Let's assume that the discount rate is 0.2. Since we do not have
information about cash inflows or revenue, it is impossible to determine the profitability of the
investment. But using the concept of NPV (Net Present Value), we can determine the
investments that cost the least to the company or the least outflow of capital. We must also take
into account that the potential for each year will be created before the beginning of this year. To
begin with, we will identify various events in which these additional capacities can be made.

1. Adding 150,000 units each 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
rupees.

2. Adding 600,000 (2*300,000) in the first year,

NPV= 2 * 3.4 / 1.2= 5.67 billion rupees.

3. Adding 300,000 units in the first and third year,

NPV= 3.4 / 1.2 +3.4 / (1.2 * 1.2 * 1.2) = 4.8 billion rupees.

In total, it is clear that the third option has the lowest outflow spent the highest NPV. Now we
have determined that we need to add 300,000 units in the first and third year, but it is important
to figure out which location will be more economical in terms of transportation costs. The
capacity addition should be done either in Delhi or Kolkata. According to the figures from the
demand table, Delhi has a higher demand than Kolkata, so there can be two ways here, adding
both of these capacities of 300,000 units in Delhi in the first and third year, or adding the first
300,000 units in Delhi and the next 300,000 units in Kolkata.

North South East West

To

From Delhi Kolkata Delhi Kolkata Delhi Kolkata Delhi Kolkata

Up to
250 258 270 260 255 250 250 270
150K

Above
150K
but less 230 240 250 245 240 230 238 250
than
300K

Since the expenses for the fifth year will continue for the next 10 years, we get the cost of
transportation for the 5th year in both of these ways.

1. Capacity addition of 600,000 (300,000 in the first and 300,000 in the second year) in Delhi.
Then the cost of transportation according to the data from the table will be,
1705 * 270 + 1705 * 250 + 100,569 * 255 + 201,138 * 230 = 7.28 billion rupees.

2. Adding capacity of 300,000 in Delhi and 300,000 in Kolkata. Then the cost of transportation
will be,

1705 * 260 + 1705 * 250 + 100,569 * 250 + 201,138 * 230 = 7.23 billion rupees.

The second option is clearly more economical. We get that the Stayfresh production network will
be most economical if they install a capacity of 300,000 units in the first year in Delhi, followed
by another 300,000 units in the third year in Kolkata.

II - The case when the expected annual growth will be 25%.

The case study says that demand growth is expected to be 25 percent a year over the next five
years, and Stayfresh plans to meet this demand. The table below shows demand indicators for the
next 5 years, and it is assumed that demand will stabilize after 5 years of growth.
Total
Year South(S) West(W) North(N) East(E) Demand
(S+W+N+E)

0 150,000 150,000 100,000 50,000 450,000

1 187,500 187,500 125,000 62,500 562,500

2 234,375 234,375 156,250 78,125 703,125

3 292,969 292,969 195,313 97,657 878,908

4 366,212 366,212 244,142 122,072 1,098,638

5 457,765 457,765 305,178 152,590 1,373,298

Stayfresh has an installed capacity of 600,000 units (300,000 in Mumbai and 300,000 in
Chennai). The total planned capacity increase for the next 5 years is 773,298 units (1,373,298 –
600,000). To match this demand, Stayfresh must increase its production capacity by either
300,000 units or 150,000 units in Delhi and/or Kolkata. Thus, Stayfresh requires an additional
capacity of 600,000 units in the next 5 years. So adding a capacity of 150,000 units entails a one-
time cost of Rs. 2 billion and that of 300,000 units is worth Rs. 3.4 billion according to the
information given. We should take into account that the discount rate is 0.2. Since we do not
have information about cash inflows or revenue, it is impossible to determine the profitability of
investments. But if we use the concept of NPV (Net Present Value), we can get investments that
cost the least for the company or the least capital outflow. We must also remember that the
potential for each year will be created before the beginning of this year. First, we must examine
the various ways in which these additional capacities can be made.

1. Adding 150,000 units each 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
rupees.

2. Adding 600,000 (2*300,000) in the first year,

NPV= 2 * 3.4 / 1.2= 5.67 billion rupees.

3. Adding 300,000 units in the first and third year,

NPV= 3.4 / 1.2 +3.4 / (1.2 * 1.2 * 1.2) = (4.8) billion rupees.

As a result, the third option has the lowest outflow of costs or the highest NPV. We have
received that we need to add 300,000 units in the first and third year, but it is important to
determine which location will be more economical in terms of transportation costs. The capacity
addition should be either in Delhi or Kolkata. According to the data from the table, Delhi has a
higher demand than Kolkata, so there may be two cases here, adding both of these capacities of
300,000 units in Delhi in the first and third year, or we can add the first 300,000 units in Delhi
and the next 300,000 units in Kolkata.
 North South East West
To

From Delhi Kolkata Delhi Kolkata Delhi Kolkata Delhi Kolkata

Up to
250 258 270 260 255 250 250 270
150K

Above
150K
but less 230 240 250 245 240 230 238 250
than
300K

Since the expenses for the fifth year will continue for the next 10 years, we will calculate the cost
of transportation for the 5th year in both cases.

1. Capacity addition of 600,000 (300,000 in the first and 300,000 in the second year) in Delhi.
After that the price of transportation according to the table will be,

157,765 * 270 + 157,765 * 250 + 152,590 * 255 + 5,178 * 230 = 12,2 billion rupees.

2. Capacity addition of 300,000 in Delhi and 300,000 in Kolkata. Then the cost of transportation
will be,

157,765 * 260 + 157,765 * 250 + 152,590 * 250 + 5,178 * 230 = 11,9 billion rupees.

The second option is clearly more economical. As a result, the Stayfresh production network will
be most economical if they install a capacity of 300,000 units in the first year in Delhi, followed
by another 300,000 units in the third year in Kolkata.
c. Decision when changing the discount rate by 0.25 or 0.15?

In this case, we assumed that the discount rate is 0.2 or 20%. At that time, we used the
"discounted cash flow" method of evaluating investments, which involves calculating the present
value of all cash flows associated with the project. But in this case, we do not know about the
inflow of funds, we only have information about their outflow. It turns out that we used the
concept of "Net Present Value" to determine the investment strategy that will cost the least,
instead of using it to evaluate the investment. Net Present Value can be interpreted as,

NPV> 0: the project earns more than the discount rate.

NPV< 0: the project earns less than the discount rate.

NPV= 0: the project earns the same amount as the discount rate.

If we only compared the cash outflow, not estimated it, changing the discount rate by 0.25 or
0.15 would not change our strategy or decision.

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

Investment strategy - there is no universal investment strategy for deciding which of the
alternatives is the best. Sometimes the choice may be simple, and sometimes not very clear,
depending on the company's 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

It turns out that the overall strategy will not work for Stayfresh. However, we have seen in this
case that the most important thing for this company is the "transportation fee". It can be seen that
the annual "transportation fee" in some of the issues discussed above is more than the "total
installation fee" of the project. When we were preparing the demand table for various estimated
growth rates of 20%, 15% and 25%, we increased capacity only in Delhi and Kolkata. This
means that it is important for this company to install more capacity in these areas in accordance
with the demand table in order to reduce transport costs. To define the investment strategy in this
case, we used the concept of "Net Present Value". However, we do not know if the project is
profitable, since the amount of cash flow or revenue was not available. It is clear that some of
these places have idle capacity only to meet a small additional demand. Thus, we will need some
more information to accurately comment on the financial feasibility of this project.