Consider a consumer goods company that is considering implementing two, sequential Information Technology projects: (1) a first stage project consisting of a high-speed Local Area Network (LAN) and, (2) a second stage project consisting of an Enterprise Resource Planning (ERP) System. If the LAN is successfully implemented, managers across different functional areas such as marketing, finance, product-design, production, etc., will use the ERP system to make coordinated decisions. The improved decision-making will not only reduce costs, but also increase revenue.

Assumptions

The LAN (by itself) does not bring any benefits. However, the LAN is necessary for the ERP system to work effectively.

The benefit from the ERP system depends on market conditions in the future. If these conditions are favorable, then the ERP system will reap higher benefits.

At the time of the LAN investment, the market conditions are uncertain. However, at the time the ERP investment (1 year after the LAN decision), all uncertainty associated with the market will be resolved (e.g., it can be assumed that here is an important decision that the government will take after 1 year that will strongly influence the demand, favorably or unfavorably).

Data

Cost of the LAN (in thousands of dollars) = 100

Time for the LAN to be implemented (years) = 1

Cost of the ERP system (in thousands of dollars) = 250

Time for ERP system to be implemented (years) = 1

ERP benefit if demand is high (in thousands of dollars) = 500

ERP benefit if demand is low (in thousands of dollars) = 100

Probability that market conditions are favorable = 0.6

Probability that market conditions are not favorable = 0.4

Question

Should the firm invest in the LAN? (For now, ignore discounting)

note: I dont even understand the thought behind this, i have the answer i just dont know how it was reached?

Here is the answer that is wrong:

ScenarioNPV(in thousands of dollars)

ProbabilityUnder favourable market conditions(high demand)-100+-250+500=1500.6

Under unfavourable market conditions (low demand)-100+-250+100=-2500.4

Expected NPV = (p Scenario NPV)=(150*0.6)+(-250*0.4)=-10

Therefore, the firm should not invest in the LAN because the expected net present value of the project will be negative (-10 thousand dollars).

Answer rating: 100% (QA)

The calculation provided in the answer is incorrect because it does not appropriately consider the t... View the full answer