Question: What advice can be given to Thakkar on his project idea?

Background:

In December 2017, Ketan Thakkar, managing director of Nippon Distributors Private Limited (Nipponply) in the state of Gujarat, India, had a business plan. For quite some time, he had been doing market research to explore the potential of an ideanamely, geographical expansion of his current business into the western Indian states of Rajasthan, Maharashtra, and Madhya Pradesh. Thakkar had seen the huge potential for profit in this expansion. With his 25 years of experience in trading plywood products, he realized that these geographical areas had large volume requirements for plywood in housing, corporate sectors, and industrial projects. Thakkar discussed his dream of expansion with his childhood friend, Ronit Shah. Based on an initial analysis, Thakkar decided to set a production goal of 45,000 units per year for the states into which he expanded, but actual production would depend on market demand. Thakkar estimated that 29,250 units could be sold per year at an average price of 2.200 per unit.' He wanted to evaluate the feasibility of the project using a cost-volume-profit (CVP) analysis. BACKGROUND Nipponply began its journey in 1994, when Thakkar conceived the idea of providing plywood and veneers to consumers. Over the years, Nipponply developed various plywood products, veneers, laminates, and flush doors, with a strategy of delivering quality products based on natural raw materials. The firm preferred to obtain 100 per cent natural raw materials for its manufacturing and built its reputation on the quality of these materials. Further, Nipponply carefully selected manufacturers who were conveniently located in places where quality raw materials were available locally. The manufacturers' modern technology combined with Nipponply's experience resulted in continuous innovation and superior products. Nipponply had also established a strong and well-connected distribution network in the state of Gujarat. The firm had grown to provide one of the widest ranges of plywood, veneers, laminates, and flush doors in Gujarat.2 MARKET POTENTIAL Thakkar's presentation predicted increasing market potential due to two new opportunities: (1) a new initiative recently launched by the government of India, and (2) changes in market trends in the Indian plywood industry. First, the government of India had undertaken an initiative to provide affordable housing to lower-income groups, middle-income groups and the economically weaker section of society? (essentially, the urban below-poverty-line population), by 2022. According to the estimate, this initiative would necessitate the construction of 114 million houses by 202210 and include the western Indian states (i.e., Rajasthan, Maharashtra, and Madhya Pradesh). Because this scheme would require plywood materials and products used for housing development, it would generate a rise in demand and a new opportunity for the plywood industry. In addition, India's plywood market was estimated to reach a value of US$5.5 billion by 2023 due to changes in market trends, such as increasing incomes, urbanization, investment in real estate, and western influence. The demand for plywood products was expected to increase among household consumers, architects, interior designers, and original equipment manufacturers and for residential- and commercial- building purposes, creating additional opportunities for the plywood industry. 11 On the basis of this preliminary analysis, Thakkar decided to pursue an expansion in the three target western states, with a trading capacity of 45,000 units. He presented the calculations to Shah for discussion. INVESTMENT NEEDED THAKKAR. Shah, according to my estimate, the investment for the expansion project would be about *29.125 million. Investments would need to be made in various fixed assets, such as information technology [IT] infrastructure, a manufacturing plant and machinery, a building or office, and other miscellaneous assets. As we have already discussed, there would be other operating expenses related to the volume of production. According to my estimates, these costs would total *7.0125 million per month (see Exhibit 3). THAKKAR. In addition to the above investments, I have estimated working capital requirements of 0.84 million per year to pay for routine expenses such as administrative costs, office supplies, electricity, and other miscellaneous costs (see Exhibit 5). Further, the estimated workforce cost would be about $2.952 million per year (see Exhibit 6). The personnel cost would be for the aforementioned regional sales managers, business development managers, sales executives, and office assistants. FINAL DECISION A comprehensive analysis followed the discussion. Thakkar's initial decision was to pursue a business plan that had a trading capacity of 45,000 units per year, but the actual production had to be based on market demand. Thakkar estimated that, ultimately, 29,250 units could be sold per year at an average price of 52,200 per unit. Nipponply could produce 29,250 units with 65 per cent capacity utilization (i.e., the lowest level of capacity). For the second and third year, Thakkar estimated that Nipponply would have 38,250 units and 45,000 units with 85 per cent capacity utilization (a moderate level of capacity) and 100 per cent capacity utilization (the highest level of capacity), respectively. The initial investment in the project would cost $29.965 million, of which $21.915 million would be drawn from the firm's own resources, the rest would come from a bank loan at an interest rate of 11 per cent (see Exhibit 7). The life of the project was estimated to be fifteen years. The salvage value of the IT infrastructure, plant, and machinery at the end of fifteen years would be negligible and therefore could be ignored. The salvage value of the building machinery at the end of fifteen years would be *250,000. Before investing in this project, Thakkar asked a consultant to review his business plan. EXHIBIT 3: EXPENSES RELATED TO THE VOLUME OF SALES PER MONTH (FOR 3,750 UNITS) Particulars Manufacturing cost Advertising expense Promotional expense Electricity expense Total expenses Amount (5) 6,682,500 165,000 82,500 82,500 7,012,500 Source: Created by the case author based on company documents. EXHIBIT 4: ESTIMATED INVESTMENT Particulars Information technology infrastructure Plant and machinery Building Other miscellaneous assets (i.e., inventory) Total investment Amount () 1,575,000 1,250,000 26,100,000 200,000 29,125,000 Source: Created by the case author based on company documents. EXHIBIT 5: ROUTINE EXPENSES PER MONTH Particulars Administrative costs Office supplies Electricity Miscellaneous Total monthly expenses Amount (5) 20,000 5,000 40,000 5,000 70,000 Source: Created by the case author based on company documents. EXHIBIT 6: PERSONNEL COSTS PER MONTH Employee Designation Regional sales managers Business development managers Sales executives Office assistants Total monthly personnel costs Number of Employees Amount (5) 1,080,000 3 720,000 6 864,000 288,000 2,952,000 3 Source: Created by the case author based on company documents. EXHIBIT 7: CAPITAL STRUCTURE Source Equity Debt (bank loan) Total capital Amount (5) 21,915,000 8,050,000 29,965,000 Source: Created by the case author based on company documents. In December 2017, Ketan Thakkar, managing director of Nippon Distributors Private Limited (Nipponply) in the state of Gujarat, India, had a business plan. For quite some time, he had been doing market research to explore the potential of an ideanamely, geographical expansion of his current business into the western Indian states of Rajasthan, Maharashtra, and Madhya Pradesh. Thakkar had seen the huge potential for profit in this expansion. With his 25 years of experience in trading plywood products, he realized that these geographical areas had large volume requirements for plywood in housing, corporate sectors, and industrial projects. Thakkar discussed his dream of expansion with his childhood friend, Ronit Shah. Based on an initial analysis, Thakkar decided to set a production goal of 45,000 units per year for the states into which he expanded, but actual production would depend on market demand. Thakkar estimated that 29,250 units could be sold per year at an average price of 2.200 per unit.' He wanted to evaluate the feasibility of the project using a cost-volume-profit (CVP) analysis. BACKGROUND Nipponply began its journey in 1994, when Thakkar conceived the idea of providing plywood and veneers to consumers. Over the years, Nipponply developed various plywood products, veneers, laminates, and flush doors, with a strategy of delivering quality products based on natural raw materials. The firm preferred to obtain 100 per cent natural raw materials for its manufacturing and built its reputation on the quality of these materials. Further, Nipponply carefully selected manufacturers who were conveniently located in places where quality raw materials were available locally. The manufacturers' modern technology combined with Nipponply's experience resulted in continuous innovation and superior products. Nipponply had also established a strong and well-connected distribution network in the state of Gujarat. The firm had grown to provide one of the widest ranges of plywood, veneers, laminates, and flush doors in Gujarat.2 MARKET POTENTIAL Thakkar's presentation predicted increasing market potential due to two new opportunities: (1) a new initiative recently launched by the government of India, and (2) changes in market trends in the Indian plywood industry. First, the government of India had undertaken an initiative to provide affordable housing to lower-income groups, middle-income groups and the economically weaker section of society? (essentially, the urban below-poverty-line population), by 2022. According to the estimate, this initiative would necessitate the construction of 114 million houses by 202210 and include the western Indian states (i.e., Rajasthan, Maharashtra, and Madhya Pradesh). Because this scheme would require plywood materials and products used for housing development, it would generate a rise in demand and a new opportunity for the plywood industry. In addition, India's plywood market was estimated to reach a value of US$5.5 billion by 2023 due to changes in market trends, such as increasing incomes, urbanization, investment in real estate, and western influence. The demand for plywood products was expected to increase among household consumers, architects, interior designers, and original equipment manufacturers and for residential- and commercial- building purposes, creating additional opportunities for the plywood industry. 11 On the basis of this preliminary analysis, Thakkar decided to pursue an expansion in the three target western states, with a trading capacity of 45,000 units. He presented the calculations to Shah for discussion. INVESTMENT NEEDED THAKKAR. Shah, according to my estimate, the investment for the expansion project would be about *29.125 million. Investments would need to be made in various fixed assets, such as information technology [IT] infrastructure, a manufacturing plant and machinery, a building or office, and other miscellaneous assets. As we have already discussed, there would be other operating expenses related to the volume of production. According to my estimates, these costs would total *7.0125 million per month (see Exhibit 3). THAKKAR. In addition to the above investments, I have estimated working capital requirements of 0.84 million per year to pay for routine expenses such as administrative costs, office supplies, electricity, and other miscellaneous costs (see Exhibit 5). Further, the estimated workforce cost would be about $2.952 million per year (see Exhibit 6). The personnel cost would be for the aforementioned regional sales managers, business development managers, sales executives, and office assistants. FINAL DECISION A comprehensive analysis followed the discussion. Thakkar's initial decision was to pursue a business plan that had a trading capacity of 45,000 units per year, but the actual production had to be based on market demand. Thakkar estimated that, ultimately, 29,250 units could be sold per year at an average price of 52,200 per unit. Nipponply could produce 29,250 units with 65 per cent capacity utilization (i.e., the lowest level of capacity). For the second and third year, Thakkar estimated that Nipponply would have 38,250 units and 45,000 units with 85 per cent capacity utilization (a moderate level of capacity) and 100 per cent capacity utilization (the highest level of capacity), respectively. The initial investment in the project would cost $29.965 million, of which $21.915 million would be drawn from the firm's own resources, the rest would come from a bank loan at an interest rate of 11 per cent (see Exhibit 7). The life of the project was estimated to be fifteen years. The salvage value of the IT infrastructure, plant, and machinery at the end of fifteen years would be negligible and therefore could be ignored. The salvage value of the building machinery at the end of fifteen years would be *250,000. Before investing in this project, Thakkar asked a consultant to review his business plan. EXHIBIT 3: EXPENSES RELATED TO THE VOLUME OF SALES PER MONTH (FOR 3,750 UNITS) Particulars Manufacturing cost Advertising expense Promotional expense Electricity expense Total expenses Amount (5) 6,682,500 165,000 82,500 82,500 7,012,500 Source: Created by the case author based on company documents. EXHIBIT 4: ESTIMATED INVESTMENT Particulars Information technology infrastructure Plant and machinery Building Other miscellaneous assets (i.e., inventory) Total investment Amount () 1,575,000 1,250,000 26,100,000 200,000 29,125,000 Source: Created by the case author based on company documents. EXHIBIT 5: ROUTINE EXPENSES PER MONTH Particulars Administrative costs Office supplies Electricity Miscellaneous Total monthly expenses Amount (5) 20,000 5,000 40,000 5,000 70,000 Source: Created by the case author based on company documents. EXHIBIT 6: PERSONNEL COSTS PER MONTH Employee Designation Regional sales managers Business development managers Sales executives Office assistants Total monthly personnel costs Number of Employees Amount (5) 1,080,000 3 720,000 6 864,000 288,000 2,952,000 3 Source: Created by the case author based on company documents. EXHIBIT 7: CAPITAL STRUCTURE Source Equity Debt (bank loan) Total capital Amount (5) 21,915,000 8,050,000 29,965,000 Source: Created by the case author based on company documents