Ceylon Steel produces steel alloy plates. The firm wants to locate a central distribution center in the
Question:
Ceylon Steel produces steel alloy plates. The firm wants to locate a central distribution center in the northern province of the country that will serve all of its regional centers. The firm evaluated five locations (Jaffna, Kilinochchi, Mannar, Mullaitivu, Vavuniya), and using the center of gravity method narrowed down its choice to Jaffna. The firm’s supply chain manager, taking the uncertainty of future demand and costs/prices into account, is considering two options over the coming three years: obtain the distribution center space needed from the spot/cash market; or lease a fixed amount of distribution center space for three years, and procure any excess distribution center space needed from the spot/cash market. She decides to evaluate both the options and has come up with the estimated figures for the Jaffna distribution center location. The firm has a demand for fifty thousand steel alloy plates per year; the firm’s distribution center requirements are one thousand square feet of distribution center space for every one thousand steel alloy plates. The demand for steel alloy plates is expected to increase by twenty percent from one year to the next, with a probability of 0.5; or the demand for steel alloy plates is expected to decrease by twenty percent from one year to the next, with a probability of 0.5. The supply chain manager anticipates the probabilities of either the demand increase or decrease to be independent and unchanged from one year to the next. The lease price for the distribution center space is fifty cents per square foot per year over the three year lease period. The spot/cash price for the warehouse space is sixty cents per square foot per year. The spot/cash price for the distribution center is expected to increase by ten percent from one year to the next, with a probability of 0.5; or the spot/cash price for the distribution center space is expected to decrease by ten percent from one year to the next, with a probability of 0.5. The supply chain manager anticipates the probabilities of either the spot/cash price increase or decrease to be independent and unchanged from one year to the next. The supply chain manager anticipates that the prices for the distribution center space and the demand for steel alloy plates fluctuate independent of each other. The firm is in a situation to meet the entire demand for steel alloy plates, and it garners a revenue of sixty one cents per steel alloy plate. The firm uses a discount rate of 0.1 for each of the three years. The supply manager takes all the costs as incurred at the beginning of the year and decides to conduct a decision tree analysis with T =2. As price and demand fluctuate independently, each transition from one year to the next is 0.25 (0.5 x 0.5). Use decision tree analysis to help the supply chain manager calculate the expected NPV of (and decide which option to choose): a) obtaining all the distribution center space from the spot/cash market,
