Global Supply Design for the Future: Bio-tech

Bio-tech, a company headquartered in the USA, meets a plant location decision in a global network with fluctuating exchange rates and demand uncertainty.

Bio-tech sells its products mainly in north America, in which the demand is currently 100,000 units per year. Each unit sells for $80. From one year to the next, demand may increase by 10 percent, with probability 0.9, or decrease by 10 percent, with probability 0.1.

Bio-tech has to decide if to set up a plant in the USA or China. In either case, Bio- tech plans to set up a plant with a rated capacity of 110,000 units.

The fixed and variable costs of the two plants are exhibited in Table below.

American Plant

Fixed Cost (dollar)

1 million/year

Variable Cost (dollar)

50/unit

Chinese Plant

Fixed Cost (yuan)

6million/year

Variable Cost (yuan)

400/unit

The exchange rate is currently 7 yuan/dollar. The American plant has greater volume flexibility. It will be able to increase or decrease production anywhere in the range of 50,000 to 180,000 units while maintaining its variable cost.

In contrast, the Chinese plant has limited volume flexibility and can produce only between 100,000 and 140,000 units. If the Chinese plant is established, Bio-tech will have to incur variable cost for 100,000 units even if demand declines below that level and will lose sales if demand rises over 140,000 units. Exchange rates are volatile; each year, the yuan is expected to increase 10 percent, with a probability of 0.8, or decline 10 percent, with a probability of 0.2. We assume that the sourcing decision will be in place over the next three years and the discount rate used by Bio- tech is k = 0.1. All costs and revenues are assumed to accrue at the beginning of the year.

Study Questions

1. Draw a decision tree to illustrate Bio-tech's alternatives between the American plant and the Chinese plant and the related sequences.

2.Calculate the NPV for both plants. Compare them and select the appropriate plant.