Allison\'s Dresswear Manufactures is preparing a stragegy for the fall season. O

Question

Allison's Dresswear Manufactures is preparing a stragegy for the fall season. One alternative is to expand its tradition ensemble of wool sweaters. A second option would be to enter the cashmere sweater market with a new line of highquality designer label products. The marketing department has determinded that the wool and cashmere sweater lines offer the following probability of outcomes and related cash flows.

                                                    Expand Wool Sweater Line

Fantastic

                                        Enter Cashmere Sweaters Line

The initial cost to expand the wool sweater line is $142,000. To ender the cashmere sweater line, the intital cost in designs, inventory, and equipment is $102,000.

A. Diagram a complete decision tree of possible outcomes. Note that you are dealing with thousands of dollars rather than millions. Take the analysis all the way through the process of computing expected NPV (last colums for each investments).

B. Given the analysis in part a, would you automatically make the investment indicated?

Expected Sales Probability Present value of cash flows from sales

Fantastic

0.5 $221,000 Moderate 0.2 $192,000 Low 0.3 $88,600

Explanation / Answer

a)

b) As the expected NPV of entering te Cashmere market is higher than expanding the current sweater line , they should enter the Cashmere market as per the NPV approach. However there is more risk involved in this option, therefore this decision should be analysed further . Thus it is not an automatic decision.

Expand Probability (1) Present Values of Cash Inflows($)(2) Initial Cost(3) NPV(2-3) Expected NPV(NPV * 1) Fantastic 0.50 221000 142000 79000 39500 Moderate 0.20 192000 142000 50000 10000 Low 0.30 88600 142000 -53400 -16020 Total Expected NPV 33480 Enter Probability (1) Present Values of Cash Inflows($)(2) Initial Cost(3) NPV(2-3) Expected NPV(NPV * 1) Fantastic 0.30 341000 102000 239000 71700 Moderate 0.40 272000 102000 170000 68000 Low 0.30 0 102000 -102000 -30600 Total Expected NPV 109100

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