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
Expected Sales	Probability			Present Value of Cash Flows from Sales				Probability			Present Value of Cash Flows from Sales
Fantastic		.5		$	196,000				.2		$	389,000
Moderate		.1			223,000				.4			231,000
Low		.4			92,100				.4			0

The initial cost to expand the wool sweater line is $132,000. To enter the cashmere sweater line, the initial cost in designs, inventory, and equipment is $100,000.
  
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.)
  

Answer 1

For Expanded wool sweater line:

1	2	3	4	5	6
Expected sales	Probability	Present value of cash flows from sales	Initial cost	NPV (3)-(4)	Expected NPV (2) *(5)
Fantastic	.5	$196,000	$132,000	$64,000	$32000
Moderate	.1	$223,000	$132,000	$91,000	$9100
Low	.4	$92,100	$132,000	-$39,900	-$15960

So, the final NPV = $64,000+$91,000-$39,900=$115,100

& Expected NPV=$32,000+$9100_$15,960=$25,140

For Enter Cashmere Sweater line:

1	2	3	4	5	6
Expected sales	Probability	Present value of cash flows from sales	Initial cost	NPV (3)-(4)	Expected NPV (2)*(5)
Fantastic	.2	$389,000	$100,000	$289,000	$57,800
Moderate	.4	$231,000	$100,000	$131,000	$52,400
Low	.4	0	$100,000	-$100,000	-$40,000
				$320,000	$70,200

So, the final NPV=$320,000

Expected NPV= $70,200