Athens Development Corporation is considering a new product that will be sensiti

Question

Athens Development Corporation is considering a new product that will be sensitive to both economic conditions and competitor response.The product manager has decided to focus on three economic conditions: weak economy, normal economy, and strong economy.Competitors either will or will not respond with a competitive product, and competitor response is unlikely unless economic conditions turn out to be strong.Annual cash flows for each of these conditions appear below.The product has a six-year life and will require an initial cash outlay of $332,000.The cost of capital is 7 percent.Should Athens invest in this product?Explain.

                      Competitor        Weak             Normal               Strong
                      Response         Economy         Economy            Economy

                         Yes               $36,500            $52,000               $73,000
                         No                $48,500             71,000                 94,000

Please complete the table of net present values below:

                Competitor        Weak             Normal               Strong
               Response         Economy         Economy            Economy

                    Yes              $ ______          $______            $______
                     No              $ ______          $______            $______

Explanation / Answer

Hi,

Please find the detailed answer as follows:

NPV = Yes

Weak Economy = -332000 + 36500/(1+.07)^1 + 36500/(1+.07)^2 + 36500/(1+.07)^3 + 36500/(1+.07)^4 + 36500/(1+.07)^5 + 36500/(1+.07)^6 = -158021.30

Normal Economy = -332000 + 52000/(1+.07)^1 + 52000/(1+.07)^2 + 52000/(1+.07)^3 + 52000/(1+.07)^4 + 52000/(1+.07)^5 + 52000/(1+.07)^6 = -84139.94

Strong Economy = -332000 + 73000/(1+.07)^1 + 73000/(1+.07)^2 + 73000/(1+.07)^3 + 73000/(1+.07)^4 + 73000/(1+.07)^5 + 73000/(1+.07)^6 = 15957.40

NPV = No

Weak Economy = -332000 + 48500/(1+.07)^1 + 48500/(1+.07)^2 + 48500/(1+.07)^3 + 48500/(1+.07)^4 + 48500/(1+.07)^5 + 48500/(1+.07)^6 = -100822.83

Normal Economy = -332000 + 71000/(1+.07)^1 + 71000/(1+.07)^2 + 71000/(1+.07)^3 + 71000/(1+.07)^4 + 71000/(1+.07)^5 + 71000/(1+.07)^6 = 6424.32

Strong Economy = -332000 + 94000/(1+.07)^1 + 94000/(1+.07)^2 + 94000/(1+.07)^3 + 94000/(1+.07)^4 + 94000/(1+.07)^5 + 94000/(1+.07)^6 = 116054.73

Table:

Yes, the project should be undertaken, since NPV is + under both the scenarios (Yes and No) under strong economy scenario.

Thanks.

Competitor Response Weak Economy Normal Economy Strong Economy Yes -158021.30 -84139.94 15957.40 No -100822.83 6424.32 116054.73

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