Answer Happy

A)Draw a decision tree in the report reflecting the uncertainty
over the next two periods. Identify each node in terms of demand
and variable cost(affected by the fluctuating in exchange rate) and
the transition probabilities. Use two decimal points in your
notation of variable cost, if needed. (Do NOT COPY PASTE! Solve
with a new decision tree)
Task 2: Sourcing Decision for Teens Forever Description: Teens Forever is a small apparel retailer of trendy and low-cost apparel for young people. Located in Melbourne, the company divides the year into four sales seasons of about three months each and brings in new merchandise for each season. The company has historically outsourced production to China, given the lower costs there. For one of its popular products, sourcing from the Chinese supplier costs 40 yuans per unit (inclusive of all delivery costs), which at the current exchange rate of 5 yuans per AUD (i.e., 1 AUD = 5 Yuan) gives a variable cost of about AUD8 per unit. The Chinese supplier, however, has a long lead time, forcing Teens Forever to pick an order size well before the start of the season. This does not leave the company any flexibility if actual demand differs from the order size. A local supplier has come to management with a proposal to supply product at a cost of AUD10 per unit but to do so quickly enough that Teens Forever will be able to make supply in the season exactly match demand. Management is concerned about the higher variable cost but finds the flexibility of the onshore supplier very attractive. The 3 | Page
challenge is to value the responsiveness provided by the local supplier. Uncertainties Faced by Teens Forever To better compare the two suppliers, management identifies demand and exchange rates as the two major uncertainties faced by the company. Over each of the next two periods (assume them to be a year each), demand may go up by 10 percent, with a probability of 0.5, or down by 10 percent, with a probability of 0.5. Demand in the current period was 1,000 units. Similarly, over each of the next two periods, the yuan may strengthen by 5 precent, with a probability of 0.5, or weaken by 5 percent, with a probability of 0.5. The exchange rate in the current period was 5 yuans per AUD. Ordering Policies with the Two Suppliers Given the long lead time of the offshore supplier, Teens Forever commits to an order before observing any demand signal. Given the demand uncertainty over the next two periods and the fact that the margin from each unit (about AUD8 at a sale price of AUD16) is higher than the loss if the unit remains unsold at the end of the season (loss of about AUD8), management decides to commit to an order that is somewhat higher than the expected demand. Given that the expected demand is 1,000 units over each of the next two periods, management decides to order 1,050 units from the Chinese supplier for each of the next two periods. If demand in a period turns out to be higher than 1,050 units, Teens Forever will sell 1,050 units. However, if demand turns out to be lower than 1,050, the company will have leftover product for which it will not be able to recover any revenue. The short lead time of the local supplier allows Teens Forever to keep bringing product in a small amount at a time, based on actual sales. Thus, if the local supplier is used, the company can meet all demand in each period without having any unsold inventory or lost sales. In other words, the final order from the local supplier will exactly equal the demand observed by Teens Forever. A Potential Hybrid Strategy The local supplier has also offered another proposal that would allow Teens Forever to use both suppliers, each playing a different role. The Chinese supplier would produce a base quantity for the season and the local supplier would cover any 4|Page
shortfalls that result. The short lead time of the local supplier would ensure that no sales are lost. In other words, if Teens Forever committed to a base load of 900 units with the Chinese supplier in each period and demand was 900 units or less, nothing would be ordered from the local supplier. If demand, however, was larger than 900 units (say, 1,100), the shortfall of 200 units would be supplied by the local supplier. Under a hybrid strategy, the local supplier would end up supplying only a small fraction of the season's demand. For this extra flexibility and reduced volumes, however, the local supplier proposes to charge AUD11 per unit if it is used as part of a hybrid strategy.