question archive The firm has to decide whether to invest $30 Million in a new enterprise system to help manage resources and meet customer demand in the face of considerable technological and market uncertainty
The firm has to decide whether to invest $30 Million in a new enterprise system to help manage resources and meet customer demand in the face of considerable technological and market uncertainty
Subject:BusinessPrice: Bought3
The firm has to decide whether to invest $30 Million in a new enterprise system to help manage resources and meet customer demand in the face of considerable technological and market uncertainty.
There can be a good or a bad result for this investment.
Good Result: A good result has a probability of .5 of occurring. Here the planned cost reductions have been realized and better integration of the supply chain is possible. Annual benefits under this scenario equal $10 million in after-tax cash flow per year over the life of the system which has been estimated as 8 years.
Bad Result: The system proves difficult and the growth in market demand for the product is lower. Annual benefits under this scenario are $2 million in after-tax cash flow per year for the 10 years.
Real Options: For these capital investments you must analyze the nature of risk in this capital investment and decide on how to adjust for that risk. You have decided to utilize an NPV analysis of the project. Now you must define project risks and utilize the concepts in real options to adjust or plan for that risk.
It will be best for you to provide an option tree graphic to show the options and then provide a table with the computations showing how you would compute the value of this project.
Scenario #1: Use 8% cost of capital in computations and compute the good result and poor result NPVs. Calculate the real option NPV using the results computed.
