Ahsan Arshad

12P01326
MBA II Section C-III

Business Policy

4/28/2014
COLD STORAGE VS KNITWEAR
Written Analysis of Case

Introduction
Ajay and Durgesh, who are about to complete their MBA are trying to analyze which business
they should start up after graduating Cold Storage or Knitwear. Ajay chose knitwear whereas Durgesh
opted for cold storage. They collected information from various sources including machinery
manufacturers and raw material suppliers and prepared feasibility studies to understand the revenue
and cost structure of their business. Both were adamant about their choice of business which resulted in
a conflict to which business their parents should opt for.
Exhibit Analysis
Setting up Cold Storage business requires a about Rs. 755,000 more than knitwear, however, the
running costs are only Rs. 2.5 million as compared to 9.2 million in knitwear business. The revenue
structure is such that knitwear generates about Rs. 12.1 million per annum which is significantly more
than Rs. 3.5 million per annum generated by the cold storage business. Similar is the case with the profit
before tax as cold storage generate only Rs. 0.867 million per annum whereas knitwear business realizes
about 2.809 million rupees per annum.
A deeper analysis of the profit shows that cold storages margin is about 25% whereas for
knitwear, its 23% - assuming that both businesses fall under same tax regime. This shows that running
costs account for 75% of the reduction in the revenues for cold storage, whereas for cold storage it is
about 77% for knitwear. This means that a further analysis of the cost structure is required to
understand why the costs are high in knitwear business and if they can be reduced to eliminate the
discrepancy.
There is more equitable distribution between the fixed and variable costs in the cold storage
business i.e. 53% and 47% respectively, as compared to knitwear business which has 12% and 88%
respectively. This means that most of the cost incurred to knitwear would be if they would be operating
at full capacity and selling all the units that are being produced. This can be beneficial for the business as
in the low demand periods, the variable cost would also go down and the profitability margin for the
business would not be affected. This diversification would not be possible in the cold storage business as
a major cost of doing business is fixed and in the periods of low demand, the cost would still be incurred
thus affecting the profitability of the business. The fixed running cost in terms of dollar amount is more
by 265,000 rupees for cold storage.
The major cost for the cold storage business is the variable cost of power followed by the
depreciation of the equipment used, whereas the major cost for knitwear is the cost of raw materials
which accounts for about 79% of the total cost. This cost is once again variable and may fluctuate
depending on the production and ultimately the demand. It is imperative therefore that demand
estimation be done accurately so that the inventory cost may be reduced.
The significant decision point for the analysis can the payback period, i.e. the time it would take
to breakeven and recover the initial investment. The payback period for cold storage is about 6.1 years,
whereas its only 1.62 years for knitwear. The knitwear business therefore is recovering half of the initial
investment in the first year of operations i.e. after a differed period of three years. Even with the
deferred period, the adjusted payback period is about 4.62 years, which is still less as compared to the
cold storage. It should be noted however, that knitwear is a slightly riskier business to venture into as
theres high competition and the cost of materials as well as the sale price is fluctuating. This shows it is
risky to enter the business as more marketing efforts are required full capacity is achieved after 3
rd
year
of business compared to cold storage where full capacity is obtained within the first year. The problem
with cold storage is that there is no expansion and therefore profits are stagnant and can only be
increased by trading operations. Not to mention the managerial problems which may emerge in trading
business. So cold storage offers a stable stream of revenue as the demand is high but no scope of
expansion, whereas knitwear is a high risk venture with greater chances of earning a high amount of
profit as well as a quicker payback.
Conclusion
Both the projects have their own merits and cons. One offers a stable stream of revenue with
lesser risk, i.e. cold storage, thus showing that Durgesh may have a risk averse nature and hence is trying
to opt for the cold storage business. Whereas, Ajay may be a risk taker and wants to earn a lot of money
by taking more risks and that is probably why he is pushing for the knitwear business. Knitwear business
should be chosen it has higher rate of return as well is a low payback period.