Question
Company A is a small manufacturer of servers that currently builds its entire product in Istanbul. As the market for servers has grown dramatically, the
Company A is a small manufacturer of servers that currently builds its entire product in Istanbul. As the market for servers has grown dramatically, the Istanbul plant has reached a capacity of 10,000 servers per year. Company A is considering two options to increase its capacity. The first option is to add 10,000 units of capacity to the Istanbul plant at an annualized fixed cost of $10 million plus $500 labor per server. The second option is to have Company B, an independent assembler, manufacture servers for Company A at a cost of $2,000 for each server (excluding raw materials cost). Raw materials cost $8,000 per server, and Company A sells each server for $15,000. Company A must make this decision for a two-year time horizon. During each year, demand for Company A servers has an 80 percent chance of increasing by 50 percent from the year before and a 20 percent chance of remaining the same as the year before. Company B's prices may change as well. They are fixed for the first year but have a 50 percent chance of increasing by 20 percent in the second year and a 50 percent chance of remaining where they are. Use a decision tree to determine whether Company A should add capacity to its Istanbul plant or if it should outsource to Company B. Consider that the discount factor for this question is 0.135.
Considering this, what would be the total profit of the company if decides to expand its current factory?
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