In this part, we compare the NPV under different volatility in the following situations:
one is NPV with game theory and the other one is the NPV without game theory.
Figure 5.3 show the result of different NPV under different volatility. When market demand under high volatility, the NPV without game theory less than the NPV with
game theory. If we do not consider the competitor’s responses, we will not change the type of investment. In our case, Foxconn do not change its strategy when market demand under high volatility. However, when the NPV of shared investment is greater than the NPV of proprietary investment, Foxconn will change its investment type. Therefore, NPV with game theory can examine how sensitive a particular NPV when we use this framework in another case study.
Figure 5.3 NPV with Game Theory versus NPV without Game Theory
Afterwards, we set two variables which are risk-free rate and market demand (
R
f and
t) to compare the value of base case and the difference expanded NPV, hoping to describe the strategy value and the flexibility between the different investment types under uncertainty by scenario analysis. Table 5.5, demonstrates the relationship between risk-free rate and the flexibility; the higher risk-free rate is, the higher expanded value and flexibility are (See Figure 5.4).( v olitility )
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Panel A. The Expanded NPV of Foxconn versus Different Volatility
Panel B. The Flexibility of Proprietary Investment versus Different Risk-free Rate
Figure 5.4 Expanded NPV and Flexibility under Different Risk-free Rate
The rise of risk-free rate enhances the market rate and also increases the interest cost.Furthermore, if the initial investment outlay (
I ) is regarded as the exercise price of
t options, the higher risk-free rate lowers the present investment outlay. Meanwhile, the higher volatility rate is, the higher value of options is, which is as same as the feature of financial options. Due to the higher volatility, the opportunity of making profit by expanding capacity is also higher as the opportunity of options in the money increases.In the influence of volatility, different volatility can change the results of subgame and causes the increase of strategic value (See Figure 5.5). When the volatility changes from 0.56 to 0.4, the result of competition would become Stackelberg Leader (I, D), and a decrease of flexibility value is covered with an increase of strategic value which improves the expanded NPV of shared investment.
Panel A. The Strategic Value of Shared Investment versus Different Risk-free Rate
Panel B. The Flexibility of Shared Investment versus Different Risk-free Rate
Figure 5.5 Strategic Value and Flexibility under Different Risk-free Rate
Table 5.6 and Figure 5.6 display the NPV under different market demand (θ ), the higher market demand is, the higher expanded value is.
Table 5.5 The Net Present Value under Different Market Demand
The Expand NPV Flexibility Strategic Value
θ base case proprietary shared proprietary shared proprietary shared
5736397
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Panel A. Foxcoon’s Expanded NPV versus Different Market Demand
Panel B. The Value of Flexibility versus Different Market Demand
Panel C. The Strategic Value versus Different Market Demand
Figure 5.6 Strategic Value and Flexibility under Different Market Demand
The strategic value in low market demand is smaller than the high marketMixed Strategy Stackelberg Leader
Mixed Strategy Stackelberg Leader
demand, and show the trade-off between the flexibility effect and the strategic effect.
When the market demand is lower than 2,736,397, Foxconn may change the action in the subgame. The changes from mixed strategy to Stackelberg leader would add the value of the expanded NPV and the strategic value.
In scenario analysis, it can obviously appraisal the value of different strategies and decide the optimal strategy to Foxconn by separating flexibility value and strategic value from expanded NPV. Moreover, if market demand changed dramatically in the future, then Foxconn adopts proprietary investment strategy will be more advantageous. Finally, Foxconn will earn monopolist profit through adopting actions of law or tough M&A strategy to prevent BYD from obtaining the Korean mobile phone orders.
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Panel A. Proprietary investment: flexible and inoffensive strategy
Panel B. Shared investment: committing and inoffensive strategy
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Figure 5.1 The Additional Value of Proprietary Investment and Shared Investment
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Notes: The combination of competitive decisions (A or B) and market demand moves (θ ) may result in one of the following market structure game outcomes:
N: Cournot Nash price competitive equilibrium outcome; S: Stackelberg leder / follower outcome;
M: Monopolist outcome; A: Abandon (0); D: Defer / stay flexible (option value)
A
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Table 5.4 The Net Present Value under Different Risk Free Rate and Different Volatility
Risk-free Rate Outlay Volatility σ
Market Structure
F,1
u
F,0
Type NPV Flexibility Strategic Value
Base case Proprietary Market Shared Proprietary Market Shared Proprietary Market Shared
2.5%
6. Conclusions
The investments between enterprises often interact with one another, as illustrated by the Foxconn case discussed above, in which a two stage decision tree is built using the options-game approach. In the first stage, Foxconn uses the M&A investment as the strategy to acquire the product ability of LG; in the second stage, Foxconn builds an industrial park in northeastern China as the options to expand. We analyze the investments between Foxconn and BYD using the game theory, which not only correctly estimates the cash flow from the time they start to invest but also eliminate the problem of underestimating the value of investment by the traditional NPV method. Indeed, Foxconn delayed BYD Electronic from being listed in Hong Kong by accusing BYD of obtaining confidential information from its former employees. The delay caused BYD to be unable to collect enough money to make M&A investment.
Next, Foxconn acquired the property rights of Diabell, which is one of LG’s component suppliers. Therefore, the strategy which Foxconn has adopted is the same as our empirical and closely coincides with the result from our analysis.
As demonstrated, using the options-game approach can distinguish the flexibility value and strategic value from the current decision-making method under uncertainty. The methodology adequately considers the uncertainty of market demand, and decides whether to invest immediately or defer to the next period. Using the expansion options to appraise the effects of an investment project, managers can manipulate different strategies in each stage. Moreover, they can analyze the feasibility of investment in each stage (including growth option, option to defer, option to abandon and option to switch), and link the game theory (dynamic or static game) to assay the effects from the response of rival. Finally, the optimal investment strategy is the one which has the maximum sum of flexibility value and strategic
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value. This research combines the real option model and game theory to investigate EMS industry investment types by taking competitor responses into consideration.
Firms may take benefits from employing this options-game framework since they can more accurately evaluate their projects by considering the flexibility and strategic reactions.
To make a comprehensive survey of this paper, when we did this study, have referred to many materials of industries, and then chosen Foxconn to be the object of my study since the keen competition of Foxconn and BYD deserves to be surveyed.
However, this paper is not meant to be a perfect and accurate description of the introduction of other investment in Foxconn but an application of our models.
According to the annual report of Foxconn in 2008, Foxconn makes R&D investment in smart phone, if it has ability to manufacture smart phone, then it will become the new largest manufacturer of high-tech mobile phone or the competitor to HTC Crop., which manufactures smart phones, and mobile computer devices. Therefore, the further research can consider the above-mentioned to create new monograph.