Topiwala Chemicals Pvt. Ltd.

This brief report analyzes the recommendations made by different managers at the executive committee meeting on Tuesday 23rd August 1999 and concludes with our recommendation.

 The manager (cost control), Mr. Santosh recommends the oxidation process is better as it has lower fixed cost (Rs. 25 lakh vs Rs. 62.50 lakh for the reduction process p.a.) and also lower breakeven (400 vs 500 for the reduction process p.a.) So in the worst case if the demand is very low would give rise to minimum losses.

 Comments: While investing in a new manufacturing plant for a new chemical, we should not take any pessimistic view. Our estimate showed, we can immediately sell 550 kg p.a. and the market is expected to grow at approximately 12% p.a. So we can also exceed the breakeven volumes of reduction process (which is 500 kg per p.a.) in the first year. For every kg produced in excess of breakeven, the rate of increase of profits, which is capture by the contribution per kg. Contribution for oxidation process =2500000/400=Rs.6250/kg Contribution for reduction process =6250000/500=Rs.12500/kg Contribution is higher for the reduction process. So reduction process yield higher profits.

 The marketing manager, Mr. DSouza, recommends the reduction process is better as it has better process efficiency (i.e. lower variable cost per kg) and also a higher capacity, since the higher fixed cost will be distributed over a larger volume of production if the market is good. This is quite likely as the immediate demand is expected to be 550 kg p.a. and likely to grow at 12% p.a.

 Comments: Likely growth in demand as huge consequences i.e. 12% p.a. Year 1 2 3 4 5 6 7 8 Likely demand (kg p.a.) 550 616 690 773 865 969 1086 1216

 The oxidation process plant will run out of its capacity by year 5 and will need expansion as its capacity is only 800 kg p.a. On the other hand, the reduction process plant may need an expansion (or even substitution by a larger plant) in the 9th year after its useful economic life. Similarly, in the first year, the total profits may be higher with the oxidation process, but in all the subsequent years (as shown later in our recommendation), the reduction process may even yield higher profits. Since the production may be higher, then both the breakeven and the higher contribution per kg of the reduction process may yield higher profits.

 Finance manager Mr. Narasimha, recommends the oxidation process is batter as it assure profits even if volume are low. Any demand beyond 400 kg p.a. assures profit using the oxidation process. The first year likely demand is only 550 kg p.a. which is marginally above the breakeven of the reduction process but has an assured profit if the oxidation is used.

 Comments: While it is true that the first years profit will be higher in case the oxidation process is used, the later years profits are expected to be higher under the reduction process, if the likely growth rate of demand actually materializes. If one takes a one year horizon, the oxidation process seems to be batter. But if a longer (8 years the economic life of the plant) horizon is taken, the reduction process may yield higher profits. Finally, if the objective is to avoid losses only, the oxidation process is batter as it has lowered breakeven.

 Personal manager, Mr. Rao recommends the reduction process is batter as it achieve breakeven at lower capacity utilization of 40% vs the corresponding figures of 50% for the oxidation process.

 Comments: The capacity utilization at breakeven is not a good indicators at all it is better to look at capacity and the breakeven individually. The reduction process is batter as it has a higher capacity and also a higher contribution per kg beyond a slightly higher breakeven 500 vs 400 kg p.a. for the oxidation.

 Works manager, Mr. Shah would to have some more time so as to collect more information.

 Comment: One would never have all the implementation for business decision and still decisions have to be made often with limited information.

 Our recommendation: If we wish to maximize the annual profit from producing and selling x kg of the chemical p.a., than Profit = (quantity sell breakeven quantity) x contribution Annual profit from x kg p.a. using oxidation process =(x 400) x 6250 = -2500000 + 6250 x Annual profit from x kg p.a. using reduction process =(x 500) x 12500 = -6250000 + 12500 x If x* be the volume when both processes gives equal profits, -2500000 + 6250 x* = -6250000 + 12500 x* x* = 3750000 / 6250 = 600kg p.a.

 So to maximize annual profits, we should follows the following decision table Interval 0x600 600x1250 Best Alternative oxidation process reduction process

Although first year process demand is likely to be 550 kg p.a., second year onwards it is likely to be more than 600 kg p.a. Also the reduction process has a higher capacity and no further expansion may be needed till the end of its economic life of 8 years as shown earlier. Hence the reduction process would be more profitable over its economic life, if the demand estimates are more.