What’s the current situation? Hurricane Maria made landfall in Puerto Rico on Se
ID: 366785 • Letter: W
Question
What’s the current situation?
Hurricane Maria made landfall in Puerto Rico on Sept. 20. The Category 5 hurricane caused catastrophic damage and a major humanitarian crisis in Puerto Rico. Hundreds of commercial and residential structures were flooded, and approximately 54 people lost their lives. Getting emergency aid to island residents remains a major obstacle, not to mention the manpower required to address the extensive property damage. Puerto Rico will likely see a much longer recovery period than Houston and South Florida, which were ravaged by Hurricane Harvey and Irma, respectively, because they lack adequate economic infrastructure to make a quick recovery from the near-total devastation.
McLaren Corporation, a U.S. Company, originally based in Boulder, Colorado, moved its headquarters to Ponce, a port city in Puerto Rico, almost 30 years ago. During that time they have grown into a multi-million dollar enterprise. Their primary market is South America, which accounts for 85% of its revenues. McLaren Corporation has taken advantage of the fact that Puerto Rico is strategically located between North America and South America, serving as the link between the United States and the Latin American markets. Puerto Rico also provides McLaren Corporation with a favorable business climate to operate in. With an economy based on the U.S. dollar, Puerto Rico offers monetary stability, and access to U.S. benefits such as social security and Medicare. Additionally, Puerto Rico offers significant tax benefits - the fixed corporate income tax rate is lower than in mainland USA.
At $13.82 per hour, the mean hourly wage rate in Puerto Rico is lower than most states in the mainland. McLaren currently employs 1,000 local residents (skilled and semi-skilled), and is the main industry in Ponce. It's ideal location as a port city facilitates easy import of raw materials and export of finished goods. The residents of Ponce will willingly attest that the local economy will not survive without McLaren Corporation.
After Hurricane Maria, McLaren Corporation’s main production facility was completely destroyed. The cost to rebuild the 19,000 square feet facility is estimated at $245 per square foot, and it will take approximately 11 months to complete. Furniture and fixtures will add another $2.3 million to the overall cost, while machinery and equipment will cost $6.7 million to replace. The major road to the port, which was also damaged in the storm, will have to be repaired at a cost of $4 million. A contingency amount of $1.5 million must be added for permits and other miscellaneous costs.
The company directors are wondering, however, if it would make more sense to move its headquarters back to the U.S. mainland. The city of Boulder, Colorado will welcome the corporation back with open arms, and is willing to provide industrial land at no cost for construction of a new premises. Because of the exorbitant freight cost to transport construction materials to Puerto Rico from the U.S., the cost to construct a new facility in Boulder is $9.00 per square foot cheaper. Furniture and fixtures will cost 18% less than it will in Puerto Rico, while machinery and equipment will cost 22% less to replace. Construction is expected to take 9 months to complete. A contingency amount of $1.5 million must be added to the budget for permits and other miscellaneous costs.
The mean hourly wage in Boulder is $19.03. Boulder has high-quality public services, excellent infrastructure, and quality schools and colleges that produce a talented workforce. The city also boasts thriving districts of culturally diverse and locally owned restaurants, bars, specialty stores and community centers. Ongoing cultural events have created an attractive collaborative environment in which to live and work.
One issue that the company directors are particularly grappling with is recruitment and training of new employees. If they remain in Ponce, they have access to a ready, well-trained workforce that can begin working as soon as the rebuilt facility is commissioned. Because the plan is not to relocate any of the current employees, a move to Boulder will mean that the company will have to recruit and train an estimated 1000 new employees. The average cost to recruit and train one new employee is approximately $5,700.
The Company has retained Denver-based architectural firm, Renier and Associates, for the planning and design work. Their fee for services rendered will be calculated at 10% of the facility construction cost of either facility. (Hint: Facility construction cost does not include fixtures, fittings, machinery, equipment, permits, and miscellaneous costs)
Who are you?
You are the Vice President of Enterprise Risk at McLaren Corporation. The Chief Executive Officer, Coleen Farrell, has asked you to evaluate both options, along with the associated impacts.
What are you supposed to do?
Provide a recommendation, via email, to CEO Farrell on which option to pursue. Apply the appropriate business writing standards for content, style, and organization in your email. [Note. You are NOT required to take into consideration time value of money and discounted cash flows in your appraisal]
Explanation / Answer
Let us evaluate the two options, whether to stay back in Ponce, Puerto Rico go back to Boulder, Colorado.
Costs for Ponce -
Cost to rebuild - 19000x245 = $4.655 Million
Furniture and fixtures - $2.3 Million
Machinery and equipment - $6.7 Million
Road repair - $4 Million
Contingency - $1.5 Million
Architectural firm, Renier and Associates cost - 10% of $4.655 Million = $0.4655 Million
Employee training cost - Nil
Total fixed costs - $19.6205 Million
Costs for Boulder-
Cost to build - 19000 x (245-9) = $4.484 Million
Furniture and fixtures - 2.3 Million x (1-18%) = $1.886 Million
Machinery and equipment - $6.7 Million x (1-22%) = $5.226 Million
Contingency - $1.5 Million
Architectural firm, Renier and Associates cost - 10% of $4.484 Million = $0.4484 Million
employee training cost - 1000 x $5,700 = $ 5.7 Million
Total costs - $19.2444 Million
Extra wages paid in Boulder compared to Ponce -
1000 x (19.03 - 13.82) = 1000 x 5.2 = $5,210 per hour
Assuming an 8-hour work day, extra wages paid - $41,680 per day
Extra wages paid in Boulder per year-
41,680 x 365 = $15.213 Million
Therefore, even though the overall construction and setup cost is slightly lower in Boulder as compared to Ponce, the wages paid are significantly lower in Ponce.
The company will be able to see around 15 Million Dollars per annum by lower wages for it's thousand staff.
Further, the corporate taxes are slightly lower in Puerto Rico as compared to Colorado. Ponce also serves as a strategic location between north and South America, which helps a lot in the business.
Its location as a port City facilitates easy Import of raw material and export of finished goods thereby increasing the overall trade.
Therefore, it makes a strong sense to rebuild the factory at its old location in Ponce, Puerto Rico rather than setting it up newly at Boulder, Colorado.
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