course material

1. (Mt) – Case study: Analyze the decision problem and discuss the stregnths
Unformatted Preview Read and review the following Case Study, “Vita Plastics Assembly
Company (VPAC).” Prepare your answers to the Problems in a computer-generated format.
The type size should be 12 point, double-spaced. The quality of thought and the style of
writing should be of a caliber consistent with graduate level work. Any graphs or plots, such
as decision trees, equations, or tables, which are included in an answer, should be generated
on a computer using a spreadsheet program or similar software. Please provide full
references for sources cited, if any. Case Study – Vita Plastics Assembly Company (VPAC)
The Vita Plastics Assembly Company (VPAC), which has its headquarters in St Louis,
Missouri, is considering opening a manufacturing plant in an overseas country and
transferring much of its current US-based production to the new plant. After extensive data
collection and visits by managers to a number of possible countries, Almeria has been
identified as the most promising country for a new plant. A site near the capital, Lasia,
appears to be highly suitable and a new state-of-the art manufacturing facility could be
constructed there very quickly. The decision on whether to go ahead with the move to
Almeria will be based on the level of monetary savings in production costs that it is hoped
would be generated over the next 10 years by opening a plant there. However, there are a
number of risks associated with these savings and, for simplicity, the level of savings has
categorized as high, medium, or low. If a move to Almeria does go ahead, VPAC will review
the success of its investment after the first five years and will have the option of
withdrawing from that country and returning operations to the USA if this appears to be
appropriate. 669-21-1 Almeria has a relatively new democracy which was created following
the overthrow of a military dictatorship that had ruled the country for nearly thirty years.
However, there is considerable poverty and unemployment rates have recently been as high
as 38%. The current government is therefore keen to attract foreign investors, but it only
has a narrow majority in the country’s parliament. Despite the efforts of the government,
widespread corruption has persisted and Almeria is ranked 5th in the World league table of
corruption. Corruption is partly responsible for the neglect of the country’s road and rail
systems which are now amongst the worst in the region. If a decision is made to relocate to
Almeria there is a risk that a new government will come into power and nationalize all
foreign investments. There is thought to be only a 0.05 probability of this happening during
the first five years, but if it did occur, the loss of assets would cause VPAC to be worse off by
$75 million in present value terms) compared to the returns that would have been
generated by continuing manufacturing in the US. Nationalization would also cause VPAC’s

2. association with the country to end immediately. There is also an estimated 0.3 probability
that within the next five years, restrictions will be imposed by the government on the
convertibility of local currency into foreign currency. This would reduce savings by an
estimated $43 million (nationalization and currency restrictions can be assumed to be
mutually exclusive events). Insurance can be purchased to cover both of these political risks
for the first five years of operations by paying a total premium which has a present value of
$16 million. (Note that the insurance can only be purchased at the start of the five years). If
the company does purchase political risk insurance and nationalization occurs in the first
five years then the insurance will only cover the loss of assets. It is expected that any
savings generated before nationalization would be canceled out by the costs of relocation
and so would have present value of $O. If nationalization does not take place it is thought
that there is a 0.6 probability that in the first five years the investment would generate high
savings having an estimated present value of $85 million. There is also an estimated 0.25
probability that medium savings, with a present value $48 million, would be earned in the
first five years and a 0.15 probability these savings will be low and only amount to $5
million. If no political insurance has been purchased currency restrictions would reduce
these savings by the estimated amount given above. At the end of the first five years the
company would have to decide whether to continue to operate the plant in Almeria for
another five years or whether to transfer operations back to the US. However, this decision
will only be considered if the savings in the first five years have been low. If a decision to
withdraw is made then the plant will be sold for a return with an estimated present value of
$10 million. If VPAC decides to continue operations in Almeria for a further five years the
risk of nationalization during this period is difficult to estimate but is thought to be between
0.1 and 0.2. However, the risk of restrictions on the convertibility of local currency is
estimated to be the same as that in the first five years. The total insurance premium to cover
these risks for the second five years would have a present value of $12.8 million. If
insurance is purchased and nationalization occurs in the second five years then it is
assumed that gross savings made before nationalization will again be cancelled out by the
costs arising from the disruption. For simplicity, the present values of other costs and
savings occurring under each set of conditions in the second five years are assumed to be
the same as those in the first 5 years, with a 20% reduction to take into account the time
value of money. However, it is thought that the probabilities of high, medium and low
returns in the second five year period will be dependent on the level of returns achieved in
the first five years as shown in the table below. 669-21-2 Second five years High Medium
Low 0.60 0.30 0.10 0.10 0.80 0.10 0.03 0.07 0.90 High Medium Low First five years For
example, the table shows that if savings in the first five years have been high then there is a
0.60 probability that high savings will be maintained in the next five years, a 0.3 probability
that only medium savings will be generated and a 0.10 probability that savings will be low.
The other two rows can be interpreted in a similar manner. It can be assumed that if the
company stays in Almeria for ten years it will sell the plant at the end of this period and
hence generate extra returns with a present value of $6 million. Problem #1 (50 points)
Analyze the decision problem faced by VPAC and recommend the policy that the company
should pursue. Clearly state any assumptions you have made. The approximate length of the

3. response should be 300 words, not including graphs, decision trees, or other figures.
Problem #2 (50 points) Discuss the strengths and limitations of your model in terms of the
usefulness of the guidance that it would provide to VPAC’s managers. The approximate
length of the response should be 300 words or more.