Alla Aeroshoes is planning to market and sell its new Bluetooth-enabled shoe in

Question

Alla Aeroshoes is planning to market and sell its new Bluetooth-enabled shoe in two markets: national and international. The local market will require an initial investment and will have cash inflows for three years. If things work out, they will invest in an expansion and sell internationally, expecting benefits for four years. Assume a MARR of 10% and a risk-free interest rate of 5 %. Consultants suggest that the volatility of the cash flows is between 35% and 50%. Discuss their expansion strategy.

Year $

0 Invest $60 Million

1 $20 Million

2 $22 Million

3 $24 Million

4 Invest $160 Million

5 $60 million

6 $85 Million

7 $100 Million

8 $120 Million

Explanation / Answer

Here we assume the the local store in the local market will work-out and generate the required cash flow for the expansion that is to be made internationally.

Now we evaluate the best case and worst case scenario and the base case scenario for the expansion that happens at year 4 and assume all the three have with equal probability

The NPV for the best case scenario, worst case and normal case is calculated as follows:

Assuming that all the three have equal probabilities of hapenning, the weighted average NPV is

262.83*1/3 -19.06*1/3 +121.89*1/3 = 121.88 Million

Hence the company can go with the expansion proposal

Year Best Case - Cash flow Worst Case Cash flow Normal Scenario - Cash flow 4 -160 -160 -160 5 90 30 60 6 127.5 42.5 85 7 150 50 100 8 180 60 120 NPV $                                          262.83 $                            -19.06 $                            121.89

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