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Holly Manufacturing

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Discuss each single one of the main risk factors that should be allowed for (in addition to WACC) in order to determine the appropriate required return on this capital investment opportunity.

In 2011, China surprisingly has taken over the United States’ position as the world’s largest producer of manufactured goods. Ross (2013) noted that, China’s industrial output had risen to 120% of the US level where in 2007, China’s total industrial production was only 62% of the US level. The huge manufacturing engine boosted the living standards by doubling the country’s GDP per capita over the last decade.

However, manufacturing growth is slowing more quickly than aggregate economic growth. Data from the government shows China's economic growth has weakened in recent years, hitting 7.7 percent in 2013, the lowest level since 1999 (New Straits Times, 2014). Growing concern on China’s manufacturing competitiveness has recently made this country losing some new factory investments to lower-cost locations, such as Vietnam.

There are three risk factors that should be addresses in order to determine the appropriate required return on this capital investment opportunity:

1) Risk of rising labor cost
According to Orlik (2014), as cited from The Wall Street Journal, Chinese private-sector wages rose 14% in 2012, and are set to increase by 10 percent or more in 2014 (Bloomberg News, 2014). This condition is driving more low-cost manufacturers out of the country and boosting consumption, according to analysts at firms including Bank of America Corp (as cited in Bloomberg News, 2014).

2) Risk of foreign-exchange markets
The currency intervention in China has been effectively subsidize their export to United States, and place a tax on imported goods (tariff) on U.S. shipment to China. American Manufacturing organization (2013) reported that China’s currency intervention has contributed to the dramatic increase in the U.S. bilateral trade deficit with China, and on the other hand, China has amassed foreign exchange reserves of more than $3.8 trillion.
Davis (2004) argued that the currency intervention [example: in China and Japan] will affect the flows of supply and demand as its influence to the interest rates. Ikenson (2013) as cited in Forbes, reported that, “…the result of massive currency interventions on the part of some 20 foreign governments, the United States has incurred heavy losses, including the dubious claim that annual trade deficits have been $200 billion to $500 billion.”

3) Risk of the customers’ high expectation in China
According to Customer Service Index (CSI) Study, as cited in the J.D. Power Asia Pacific 2013, “Overall customer satisfaction with after-sales service at authorized dealerships in China declines in 2013, largely due to rising customer expectations toward the service experience.” People in China now are demanding innovative products that require engineering processes and manufacturing capabilities that, unfortunately, many local producers do not yet adequately possess. Eloot, Huang, and Lehnich (2013) stated, “China’s automakers face a similar challenge: consumers perceive their brands as lower in quality, even compared with foreign brands assembled in nearby Chinese factories.”

References

Karel, E., Huang, A., and Lehnich. M. (June 2013). New era of manufacturing in China. McKinsey & Company. Retrieved from http://www.mckinsey.com/insights/manufacturing/a_new_era_for_manufacturing_in_china

Rose, J. (September 2013). Key trends in globalization. Retrieved from http://ablog.typepad.com/keytrendsinglobalisation/2013/09/china-has-overtaken-the-us.html

http://www.nst.com.my/world/china-manufacturing-growth-slows-to-8-month-low-govt-data-shows-1.600810#ixzz32ANbGBc9

http://online.wsj.com/news/articles/SB10001424127887324767004578488233119290670

http://www.bloomberg.com/news/2014-01-06/china-wages-seen-jumping-in-2014-amid-shift-to-services-.html

https://global.vanguard.com/international/common/pdf/currencyrevaluationEN.pdf

http://www.forbes.com/sites/danikenson/2013/01/08/foreign-currency-manipulation-does-not-warrant-washingtons-attention/

http://americanmanufacturing.org/category/issues/china/china-and-currency-manipulation#sthash.CJwv2BBU.dpuf

http://www.jdpower.com/press-releases/2013-china-customer-service-index-csi-study#sthash.ZDICgLhV.dpuf

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