TAILIEUCHUNG - Build to order and entry exit strategies under exchange rate uncertainty

Under uncertainty of exchange rate, we extend the build to order production model of Lin et al. (2002) by considering the export-oriented manufacturer to make decisions to switch production location freely between domestic and foreign ones. When we transfer the production location from domestic (foreign) to foreign (domestic), and the production location transferring cost and the drift of real exchange rate are both equal to zero, then the optimal entry and exit threshold value of Cobb-Douglas production function are equal, no matter whether we use real options or net present value method. | Yugoslav Journal of Operations Research 14 (2004), Number 2, 193-208 BUILD TO ORDER AND ENTRY/EXIT STRATEGIES UNDER EXCHANGE RATE UNCERTAINTY Chin-Tsai LIN, Cheng-Ru WU Graduate Institute of Business and Management, Yuanpei University of Science and Technology Taiwan, . ctlin@ & alexru00@ Received: July 2002 / Accepted: February 2004 Abstract: Under uncertainty of exchange rate, we extend the build to order production model of Lin et al. (2002) by considering the export-oriented manufacturer to make decisions to switch production location freely between domestic and foreign ones. The export-oriented manufacturer is risk neutral and has rational expectations. When we transfer the production location from domestic (foreign) to foreign (domestic), and the production location transferring cost and the drift of real exchange rate are both equal to zero, then the optimal entry and exit threshold value of Cobb-Douglas production function are equal, no matter whether we use real options or net present value method. Thus export-oriented manufacturer can make decisions at the optimal transfer threshold value for transferable locations wherever the production locations are. It provides the export-oriented manufacturer with another way of thinking. Keywords: Build to order, entry and exit, exchange rate uncertainty, real options. 1. INTRODUCTION Following the collapse of the Bretton Woods System in 1973, industrialized uncertainty significantly influences the cash flows of exporting manufacturers and influences export-oriented manufacturer’ choices concerning the production location. Most industries use real exchange rates to determine expected remuneration. Blonigen (1997) and Tomlin (1998) have claimed that the threshold value of the real exchange rate is an important decision-making index. Management’s flexibility to respond to alter future market conditions increases an investment opportunity’s value by improving its upside potential .

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