Allison’s Dresswear Manufacturers is preparing a strategy for the fall season. O
ID: 1175385 • Letter: A
Question
Allison’s Dresswear Manufacturers is preparing a strategy for the fall season. One alternative is to expand its traditional ensemble of wool sweaters. A second option would be to enter the cashmere sweater market with a new line of high-quality designer label products. The marketing department has determined that the wool and cashmere sweater lines offer the following probability of outcomes and related cash flows.
Expand Wool
Sweaters Line
Enter Cashmere
Sweaters Line
The initial cost to expand the wool sweater line is $161,000. To enter the cashmere sweater line, the initial cost in designs, inventory, and equipment is $121,000.
a. Calculate net present value if, Allison’s Dresswear Manufacturers decides to: (Negative amounts should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to the nearest whole dollar.)
Expand Wool
Sweaters Line
Enter Cashmere
Sweaters Line
of Cash Flows
from Sales Probability Present Value
of Cash Flows
from Sales Fantastic .3 $ 244,000 .3 $ 317,000 Moderate .4 181,000 .4 310,000 Low .3 90,600 .3 0
Explanation / Answer
We need to find NPV of both the options if we want to select between the two options. One with the higher NPV would add higher value to stock holders and firm and hence should be selected.
NPV = PV of cash inflows - Cash outflow
PV of cash inflows for two options need to we caculated by weighted averaging them with the probabilities.
PV of cash inflows for expansion = (0.3 * 244,000) + (0.4 * 181,000) + (0.3 * 90,600) = 73,200 + 72,400 + 27,180 = 172,780
NPV = 172,780 - 161,000 = 11,780
PV of cash inflows for Cashmere = (0.3 * 317,000) + (0.4 * 310,000) + (0.3 * 0) = = 95100 + 124000 + 0 = 219,100
NPV = 219,000 - 121,000 = 98,100
NPV of entering Cashmere sweater line is higher. Hence that option should be selected.
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