Question

B&B has a new baby powder ready to market. If the firm goes directly to the market with the product, there is only a 60 percent chance of success. However, the firm can conduct customer segment research, which will take a year and cost $1.14 million. By going through research, the company will be able to better target potential customers and will increase the probability of success to 75 percent. If successful, the baby powder will bring a present value profit (at time of initial selling) of $19.1 million. If unsuccessful, the present value payoff is only $6.1 million. The appropriate discount rate is 14 percent.
Required:
Calculate the NPV for the firm if it conducts customer segment research and if it goes to market immediately.

Answer 1

Answer:

NPV = $13.9m

NPV = $11.05m (if conducts customer segment research)

Explanation:

DATA

Successfull probability = 60%

Unsuccessful probability = 40%

Initial selling = $19.1m

Unsuccessful present value  = $6.1 m

Research cost = $1.14m

Discount rate = 14%

Solution ( NPV If the firm goes to market immediately)

NPV = (Successful probability x initial selling) + (Unsuccessful probability x Unsuccessful present value)

NPV = (60% x $19.1m) + ( 40% x $6.1 m)

NPV = $11.46m + $2.44m

NPV = $13.9m

Solution (NPV if the firm conducts customer segment research)

NPV = ((Successful probability x initial selling) + (Unsuccessful probability x Unsuccessful present value)/1+discount rate ) - research cost

NPV = $\frac{13.9m}{1+0.14} - 1.14$

NPV = $12.19m - $1.14m

NPV = $11.05m

Note: We can calculate NPV if the firm conducts customer segment research by dividing NPV calculated above by (1+discount rate) and research cost is deducted from the whole.