Question

Ang Electronics, Inc., has developed a new DVDR. If the DVDR is successful, the present value of the payoff (when the product is brought to market) is $33.1 million. If the DVDR fails, the present value of the payoff is $11.1 million. If the product goes directly to market, there is a 60 percent chance of success. Alternatively, Ang can delay the launch by one year and spend $1.21 million to test market the DVDR. Test marketing would allow the firm to improve the product and increase the probability of success to 90 percent. The appropriate discount rate is 10 percent.

Calculate the NPV of going directly to market and the NPV of test marketing before going to market. (Enter your answers in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.)

NPV Go to market now $

NPV Test marketing first $

Should the firm conduct test marketing? No Yes

Answer 1

Answer:

NPV Go to market now $24,300,000

NPV Test marketing first $26,880,909

Should the firm conduct test marketing? Yes

Explanation:

• NPV Go to market now

60% chance of success

NPV of cash inflow if has success is $33,100,000 -  CFS

NPV of cash inflow if failure is $11,100,000 -  CFF

NPV = CFS × Prob.of Success + CFF × Prob. of Failure = $33,100,000×0.60 + $11,100,000×0.40 = $19,860,000+$4,440,000 = $24,300,000

• If the test marketing is conducted and after 1 year DVDR is brought into market:

Cash outflow for conducting research is $1,210,000

Prob. of Success is 90%

Cash inflow is $33,100,000 - Succes s - CFS

Cash inflow is $11,100,000 - Failure  - CFF

Discount rate: 10%

The payoff will be received after 1 year

NPV = (CFS × Prob.of.Success + CFF × Prob.of-Failure)/(1+r)n - CFResearch        

(CFS × Prob.of.Success + CFF × Prob.of-Failure) =       $33,100,000 * 0,90 + $11,100,000 * 0,10 =  $30,900,000  

(1+r)^n = (1+0,10)^1 =  1,10  = $30,900,000  / 1,10 = $28,090,909    

NPV - CFResearch = $28,090,909 - $1,210,000 = $26,880,909    

Chance of Failure it's determined as 1 - 0,60 = 0,40