Lake Nakuru, Kenya
On his first day, Jim Kiniti was called by Senior Manger Finance in his spacious office at the Development Bank of Kenya. There were two other young officers. Addressing the three, the Manager asked them to prepare a preliminary proposal for setting up of a Fertilizer Plant. “We have to settle on some basic issues of location, market and technology”, said he while passing a folder to them.
Indeed, it was a complex situation. The plant could be located at Nairobi or Nakuru, the market could be local or export and in technology, there were two choices: capital intensive or labour intensive. This may entail as many as eight earning forecasts which is quite mind boggling. Though fresh from University, Kiniti solved the problem in a short time through Differential Analysis.
“What is common in various scenarios is not relevant to us”, he started confidently. Continuing he said that we must look at spots where there were differences and pickup the best. This eased the task and they came up with a suggestion that the plant maybe located at Nakuru using capital intensive technology for exporting the product to the neighboring countries. When they went to the manager with their suggestions, he shouted, “Bring me the calculations and not what you feel, you dummies”
- Development Bank
Prime purpose of Development Banks to boost up industrial growth. They are growth motivated not profit-motivated.
Before jotting down hard facts of the case, let me briefly comment on the three cities to be described in this proposal:
1. NAIROBI: Situated at an elevation of 1660 m, Nairobi is the capital of Kenya. It is popularly known as the “Green City in the Sun” and attracts a large of tourists despite being labeled as “dangerous”. It is developing fast as an industrial city and creating jobs which would hopefully reduce street crimes like “snatch and run”.
2. Nakuru lies at a distance of 150 km from Nairobi. It has plenty of tourist attractions being home to Lake Nakuru famous for a vast number of flamingoes.
3. Kisumu: About 200 km away, is a place called Kisumu. It literally means a “place of barter trade”. It is a port-city on Lake Victoria, a freshwater body second only to Lake Michigan in the USA. It is an export point to the neighboring countries of Uganda and Tanzania.
- Capital Intensive
A business process or an industry that requires large amounts of money and other financial resources to produce a good or service. A business is
- Labour intensive
A labour intensive business is one in which the main cost is that of labour, and it is high compared to sales or value added. Such industries are anti-inflationary and they generate demand for cheap products.
- differential analysis
Decision making technique in which evaluation is confined to only those factors which are different or unique among possible alternatives. It usually involves fo
Now I would briefly narrate background information on the case:
1. The plant would produce 10,000 tons of fertilizer each year.
2. Raw Material costs would be $.50 per ton.
3. Raw Material Requirements would be three times of the finished goods.
4. Transport cost would be $0.25 per ton per km
5. The plant could be located at Nairobi or Nakuru.
6. The product can be sold locally at $725 or exported at $825 FOB Kisumu. Exports fetch higher prices due to logistic reasons and higher demand.
7. Location could be near Raw Material source ( Nakuru ) or Nairobi, which is main local market.
8. If labour intensive technology is used, the capital costs would be six million dollars which in case of capital intensive would be much higher at $13 million.
9. Unit Costs would be $.824 in case of Labour Intensive and much lower at $.734 per ton for the alternate.
The working is given as under:
Differential Analysis makes life easy. It would lead to the same decision which can be taken through simulation i.e. trying all possible out-comes.
Sometimes, Differential Analysis is considered the same as Incremental Analysis or Marginal Analysis. Differential Analysis differs from the two others as it finds a difference between two independent proposals and not additional cost or price or productivity. If we are considering what would be addition in cost if another unit is produced, this would be known as incremental costs. But what would be additional investment, if we discard a weaving plant and go for a sugar plant. If so, we are in the area of Differential Analysis.
Marginal Analysis and Incremental Analysis are, however, the same.
More by this Author
This is in continuation of a hub: Case Study: PERT/CPM – calculating floats. Some terms used in the said hub would be repeated for a complete understanding of the concepts and techniques. A float is a slack or...
When you have a choice between two or more alternatives and you have to select one, you are making a decision. If there is no choice, you will have to simply follow or obey. So a decision implies a selection, a choice,...
Profit is the yard-stick for evaluating performance of any business concern. Since ultimate profit depends upon plan and control, cost accounting plays a vital role. Previously, cost accounting was mostly engaged in...