1. Ergonomic Advantage manufactures office fumiture. The firm is interested in e
ID: 2648762 • Letter: 1
Question
1. Ergonomic Advantage manufactures office fumiture. The firm is interested in ergonomic" products that are designed to be easier on the bodies of office workers' who suffer from aliments such asback and neck pain due to sitting for long periods. Unfortunately customeracceptance ofergonomic fumiture tends to unpredictable, so a wide range ofmarket response is possible. Management has made the following two year, probabilistic estimate ofthe c flows associated with the project amanged decision tree fomat ash ($000). Assuming Ergonomic Advantage has an abandonment option at the end ofthe first year under which it will recover $7 million of the initial investment in year2. Ergonomic Advantage has a cost of capital of 5% Path $9,000 1 $6,000 $7,000 $8,000 $3,000 $7,000 3 Abandon a. What the value of the ability to abandon the project? is Path 3 (abandon). What is Ergonomic Advantage's overall weighted NPV? Path 1 Path 2 Should Ergonomic Advantage take proceed with this project and why?Explanation / Answer
a)
Value of ability to abondon the project = 7000/1.15^2 + 3000/1.15 - 8000
Value of ability to abondon the project = - $ 98.30
b)
Path 1 => NPV = 9000/1.15^2 + 6000/1.15 - 8000
NPV = $ 4022.68
Path 2 => NPV = 7000/1.15^2 + 6000/1.15 - 8000
NPV = $ 2510.40
c) Should Ergonomic Advantage take proceed with this project and why
NPV of the Project = 0.60*(0.3*4022.68 + 0.7*2510.40) + 0.40*-98.30
NPV of the Project = $ 1739.13
Decision : Yes Ergonomic Advantage take proceed with this project as its weighted average NPV is positive.
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