This case study is based on a real case; of course, anonymized for obvious reasons. The case study

considers the problem of Agricultural Machinery Exporters Company $($AMECO$),$ a company

considering relocating its manufacturing facilities from the UK to an overseas country. In making its

decision, the company needs to take into account a number of political risks that it will face if it decides

to go ahead with the relocation. The decision problem is made complex by the large number of

combinations of possible events that can occur and the challenges that arise from the need to structure

the problem in a way which makes analysis of the problem tractable. Note that all of the monetary

values presented in the case have already been expressed as present values to avoid the additional

complication of applying discounted cash flow analysis to the data. Carefully read the case study and

answer the question that follow.

AMECO Relocation Decision Problem

Agricultural Machinery Exporters Company $($AMECO$),$ which has its headquarters in the UK$,$ is

considering opening a manufacturing plant in an overseas country and transferring much of its current

UK$-$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 is categorised as either high, medium or low. If a move to Almeria does go ahead,

AMECO 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 UK if this appears to be appropriate.

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 $5$th 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 $0\mathrm{.}05$ probability of this happening

during the first five years, but if it did occur, the loss of assets would cause AMECO 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 UK$.$ Nationalization would also cause AMECO$$s association with the

country to end immediately. $2$

Insurance can be purchased to cover the political risk of nationalization 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 $$0.$ If nationalization does not take place it is

thought that there is a $0\mathrm{.}6$ 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 $0\mathrm{.}25$ probability

that medium savings, with a present value $$48$ million, would be earned in the first five years and a

$0\mathrm{.}15$ probability these savings will be low and only amount to $$5$ million.

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 UK$.$ 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 AMECO decide to continue operations in Almeria for a further five years the risk of nationalization

during this period is estimated to be $0\mathrm{.}15$