Task 2: Sourcing Decision for SolarPower Description: SolarPower, an Australian manufacturer of solar panels, sells its products in Australia and New Zealand. At present, the annual demand of 40W 12V monocrystalline solar panels is 90,000 units, each sells for AUD 70. Although demand for solar panels is expected to grow rapidly due to rising electricity bill in recent years, there are some downslides risks if the economy slides. From one year to the next, demand may increase by 20%, with probability of 0.7, or decrease by 20% with probability of 0.3. SolarPower can either build a plant in Australia or China. In either case, SolarPower plans to build a plant with an average capacity of around 100,000 panels. The fixed and the variable costs of the two plants are shown in Table 1. It needs to be note that the fixed costs are given per year rather than as a one-time investment. The Australian plant is more expensive but has volume flexibility. The plant can increase or decrease production in the range of 60,000 to 130,000 panels while maintaining its variable cost. So, theoretically it can match exactly the demand within this range. The Chinese plant is cheaper to build and run but has no volume flexibility and can produce only at designed capacity which is 100,000. If the Chinese plant is built, SolarPower will incur variable cost for 100,000 panels even if demand drops below that level and will lose sales if demand increases above that level. The same applies to the Australian plant but with a greater volume flexibility (i.e., between 60,000 and 130,000 units) the impact will be much smaller. To simplify the matter, it is assumed that the holding cost of the unsold solar panels is exorbitant and therefore they will be scrapped and not stored for use in the following year. Exchange rates are volatile. At present, the exchange rate is five Chinese yuan to one Australian dollar. Owing to the rising economy in China for the last three decades, the Chinese yuan would likely maintain its strong position in the international money market. Each year, the Chinese yuan is expected to rise by 10%, with a probability of 80%, or a drop by 10%, with a probability of 0.2. It can be assumed that the sourcing decision will be in place in the next two years and the discount rate used by SolarPower is k = 0.1. All costs and revenues are assumed to accrue at the beginning of the year. So, the current year with a demand of 90,000 panels and an exchange rate of 5 yuan/AUD can be regarded as period 0 and the following two years as periods 1 and 2. A Potential Hybrid Strategy SolarPower is also considering a potential hybrid sourcing strategy which combines the lower cost of production in China and the flexibility of local sourcing. Under this strategy, the company will still set up a plant in China as in the offshoring option but only produce 80,000 panels every year. If the demand exceeds 80,000, SolarPower will purchase the panels from other local suppliers at a price of AUD70 per unit (including ordering and shipping cost). With such a high unit cost the company will not make profit for anything above 80,000 panels but such arrangement can help keep the customers and not losing the market shares to competitors. Quantitative Questions: a) Draw a decision tree in the report reflecting the uncertainty over the next two periods. Identify each node in terms of demand and variable cost (affected by the fluctuations in exchange rate) and the transition probabilities. Use two decimal points in your notation of variable cost, if needed. (8 marks) b) If management at SolarPower is to either build a plant in China or Australia as planned, which one would you recommend? What is the NPV of the expected profit over the next two periods for each of the two choices? (6 marks) c) What do you think about the hybrid strategy? Is it worth doing it? Evaluate the NPV of the expected profit over the next two periods for the hybrid option. (6 marks) Qualitative Question: d) Conduct your own research and find out how the decision tree methodology can be applied to the solar panel manufacturing industry. As planning of activities in the upstream, midstream, and downstream of a solar panel supply chain requiring the use of the decision tree methodology can vary, you may wish to discuss the application in the different aspects of the supply chain operation based on the uncertainties involved.