Jim Toreson, chairman and CEO of Xebec Corporation, a Sunnyvale, California, manufacturer of disk-drive controllers, is trying to decide whether to switch to offshore production. Given Xebec's well-developed engineering and marketing capabilities, Toreson could use offshore manufacturing to ramp up production, taking full advantage of both low-wage labor and a grab bag of tax holidays, low-interest loans, and other government largesse. Most of his competitors seem to be doing it.
The faster he follows suit, the better off Xebec would be according to the conventional discounted cash-flow analysis, which shows that switching production offshore is clearly a positive NPV investment. However, Toreson is concerned that such a move would entail the loss of certain intangible strategic benefits associated with domestic production.
a. What might be some strategic benefits of domestic manufacturing for Xebec? Consider the fact that its customers are all U.S. firms and that manufacturing technology-particularly automation skills-is key to survival in this business.
b. What analytical framework can be used to factor these intangible strategic benefits of domestic manufacturing (which are intangible costs of offshore production) into the factory location decision?
c. How would the possibility of radical shifts in manufacturing technology affect the production location decision?
d. Xebec is considering producing more sophisticated drives that require substantial customization. How does this possibility affect its production decision?
e. Suppose the Taiwan government is willing to provide a loan of $10 million at 5% to Xebec to build a factory there. The loan would be paid off in equal annual installments over a five-year period. If the market interest rate for such an investment is 14%, what is the before-tax value of the interest subsidy?
f. Projected before-tax income from the Taiwan plant is $1 million annually, beginning at the end of the first year. Taiwan's corporate tax rate is 25%, and there is a 20% dividend withholding tax. However, Taiwan will exempt the plant's income from corporate tax (but not withholding tax) for the first five years.
If Xebec plans to remit all income as dividends back to the United States, how much is the tax holiday worth?
g. An alternative sourcing option is to shut down all domestic production and contract to have Xebec's products built for it by a foreign supplier in a country such as Japan. What are some of the potential advantages and disadvantages of foreign contracting vis-`a-vis manufacturing in a wholly owned foreign subsidiary?

  • CreatedJune 27, 2014
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