Chapter 6

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Chapter 6: Network Design in an Uncertain Environment Exercise Solutions 1. Answer: Using a decision tree to analyze this decision reveals a dominant answer. Not only does outsourcing to Molectron result in a higher expected incremental profit, but also in every possible outcome, the Molectron option results in a higher profit. Therefore, according to the financial analysis, no matter what the risk tolerance of the management at Moon, they should choose to outsource rather than to increase their own facility. There are other factors that could play into this decision, however, which are harder to quantify. Two are particularly important: the performance of Molectron and the strategic decision regarding where Moon should focus its efforts. It’s possible that Molectron’s quality and delivery performance would be worse than if Moon made the machines themselves. If this is the case, it could counter the financial advantage Moletron presents. Secondly, building the additional plant may increase Moon’s manufacturing competence and this may be a key to their success down the road. Conversely, the new plant could distract Moon from other aspects of their business making outsourcing more attractive. All these factors should be considered when making the decision. Solution using Decision Tree: Input: Current demand: D 0 =10,000 Probability of demand goes up in next year: P up = 80% Probability of demand remains the same: P same = 20% Demand increasing rate: u d =150% Increased capacity: M = 10,000 Annual fixed cost of new capacity: C fix = \$10,000,000 Labor cost per server of new capacity: C labor = \$500 Raw material cost per server: C raw = \$ 8,000 Labor cost per server by Molectron: C Molectron = \$2,000 Price per server: P = \$15,000 Probability of Molectron’s price goes up in the second year: 50% Probability of Molectron’s price remains the same in the second year: 50% Molectron’s cost increasing rate: u c = 120% Output: To draw the decision tree and analyze this problem, we need to calculate for each scenario the total demand and cost per server for both 1 st and 2 nd years. 1 st yr. demand if it goes up: D u = D 0 * 150% = 15,000 1 st yr. demand if it remains the same: D d = 10,000 There are four scenarios of 2 nd demand: D uu , D ud , D dd , D du . The subscripts mean the demand changes. For example, D uu means demand has been going u p for two years, and D ud means the demand went u p and went d own or remained the same.

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D uu = D 0 * u d * u d = 10,000 * 150% * 150% = 22,500 D ud = D 0 * u d = 10,000 * 150% = 15,000 D dd = D 0 = 10,000 D du = D 0 * u d = 10,000 * 150% = 15,000 Please note that D uu = 22,500 exceeds the capacity of 20,000, hence Moon Micro can only set 20,000 demand in this scenario. And we should calculate revenue of this scenario accordingly. Independent of demand changes, cost per server by Molectron in the 2
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