Economics

Case Study –Brexit Some have said that June 23rd, 2016 will go down as Britain’s Independence Day! Others have been less positive about Britain’s decision to leave the European Union. Financial markets, facing new found uncertainty, plunged. The pound fell hard against the dollar to a 30-year low of $1.32. This decision caused ripples around the world, especially in Europe. Britain is a strong consumption market for European goods. Brexit vote also caused uncertainty in many of the world’s markets for a number of reasons. Britain, as the world’s 6th largest economy, is a member of the influential G7 group of nations and an important hub for many industries, notably international finance. It’s colonial past means it is influential around the world, and an important trade partner to many nations. Britain was the home of the industrial revolution, and is in many respects, the birthplace of modern economics particularly through the likes of John Maynard Keynes, Adam Smith, Alfred Marshall and others. It was felt by many that if Britain, long a champion of free trade, can vote to revoke a regional trade deal, how much faith can businesses worldwide put in other international economic agreements? Economists understand comparative advantage and the gains from trade. To illustrate some of the impacts of Brexit consider the Rolls Royce Company (RRC). RRC is a designer, distributer, and manufacturer of power systems for aviation and auto manufacturers. They are the former owner of car brands like Bentley and Rolls Royce, both of which they sold in 1971 (now owned by Volkswagen). Assume Rolls Royce can produce two things, aircraft parts, which they sell to firms like Airbus, Boeing etc., or car parts, which they currently sell to a number of car manufacturers. They are considering expanding their business, and are looking at strategic options. RRC can produce either 50 car parts, 100 aircraft parts, or a combination or both. After exploring the market, RRC finds that Volkswagen is also producing both car parts and aircraft parts and may be open to trade, the benefits of which RRC wants to consider. Volkswagen can produce either 120 car parts, 40 aircraft parts, or a combination or both. Part 2 The market for aircraft parts has been stable for several decades, with no significant changes to supply chains, or no new competitors or customers entering the market. Both supply and demand are settled, and price is relatively stable. Explain and illustrate using appropriate supply and demand curves, they likely short and medium terms implications on this established equilibrium in the market generally, and particularly for RRC of Brexit. Explain in detail what the change in the equilibrium price and quantity will be, and illustrate this in detail. Propose strategies that could be pursued by the companies and or governments to alleviate the worst impacts of Brexit. Part 3 RRC is considering a development of a new manufacturing plant in North America, to help alleviate any future disadvantages brought about by the impacts of Brexit. This plant would be to serve Boeing on a long term contract, and would be additional to existing business. The project has an initial construction cost of £615 million. They will depreciate these assets over 25 years, after which the contract will have expired, and the plant is expect to be ready for repurposing with only a residual value of £45 million. The nett increase in cash flow expected during this contract is as follows: £42million in Year 1, increasing by 5% per annum throughout the lifetime of the contract. RRC is considering this development. Alternative uses of the capital are available, with RRC expecting the best alternative use (a plant in Brazil to serve the same contract) would yield an IRR of 9%. Make recommendations in regards to whether RRC should go ahead with this project showing workings.