Question

The manager for a growing firm is considering the launch of a new product. If the product goes directly to market, there is a 40 percent chance of success. For $165,000, the manager can conduct a focus group that will increase the product’s chance of success to 55 percent. Alternatively, the manager has the option to pay a consulting firm $380,000 to research the market and refine the product. The consulting firm successfully launches new products 70 percent of the time. If the firm successfully launches the product, the payoff will be $1.80 million. If the product is a failure, the NPV is zero.
Calculate the NPV for each option available for the project. (Do not round intermediate calculations. Enter your answers in dollars, not millions of dollars, i.e. 1,234,567)
NPV
Go to market now $
Focus group $
Consulting firm $
Which action should the firm undertake?
A. Go to market now
B. Consulting firm
C. Focus group

Answer 1

Answer:

NPVs:

• Go to market now  = $720,000
• Focus group   = $825,000
• Consulting firm  = $880,000

Which action should the firm undertake?

• B. Consulting firm

Since the NPV of hiring a consulting firm is higher, then that option should be taken.

Explanation:

the expected values:

Go to market now  = 40% x $1.8 million = $720,000

Consulting firm   = 55% x $1.8 million = $990,000

Focus group  = 70% x $1.8 million = $1,260,000

the expected NPVs:

Go to market now  = $720,000

Consulting firm   = $990,000 - $165,000 = $825,000

Focus group  = $1,260,000 - $380,000 = $880,000