ToughMetals, a leading trading company, imports specialised steel from several Far Eastem countries and exports it to automobile manufacturers around the globe. The imported steel is first shipped to Singapore, where it is stored in a leased warehouse, and then shipped to the manufacturers

ToughMetalsilease of its warehouse wil be expiring in the next few weeks. The company is exploing lwo options for the next iwo years.

The first option is to renew the lease for two years. This will involve a payment of Rs 100 Lakh at the beginning of the first year and Rs 110 Lakh at the beginning of the second year. The size of the warehouse is 230.000 sft.

The second option is to buy warehouse space at spot price. The spot price for the first year is Rs 50/sft. Spot price for the second year is uncertain. It has been estimated that the spot price for the second year will be Rs 70/sft with 80% probability or Rs 90/sft with 20% probability.

The payments are to be made at the beginning of each year.

The space requirement for the first year is 150,000 sft. The space requirement for the second year is uncertain. It has been estimated that the space requirement for the second year will be 160,000 ft with 40% probability or 200,000 sft with 60% probability.

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1. Which option has the least expected cost? Assume discount rate is 10% and spot price and space requirement are independent events
2. Show all calculations.
3. Draw a neat and well-labelled Probability/Decision tree.

Answer rating: 100% (QA)

Answer Option 1 Renew the Lease The expected cost of renewing the lease for two years is calculated ... View the full answer