A European apparel manufacturer has production facilities in Italy and China to serve its European market, where annual demand i
s for 1.9 million units. Demand is expected to stay at the same level over the foreseeable future. Each facility has a capacity of 1 million units per year. With the current exchange rates, the production and distribution cost from Italy is 10 euro per unit, whereas the production and distribution cost from China is 7 euro. Over each of the next three years, the Chinese currency could rise relative to the euro by 15 percent with a probability of 0.5 or drop by 5 percent with a probability of 0.5. An option being considered is to shut down 0.5 million units of capacity in Italy and move it to China at a one-time cost of 2 million euros. Assume a discount factor of 10 percent over the three years. Do you recommend this option?
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