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 $34.8 million. If the DVDR fails, the present value of the payoff is $12.8 million. If the product goes directly to market, there is a 40 percent chance of success. Alternatively, the company can delay the launch by one year and spend $1.38 million to test market the DVDR. Test marketing would allow the firm to improve the product and increase the probability of success to 70 percent. The appropriate discount rate is 12 percent.
Calculate the NPV of going directly to market and the NPV of test marketing before going to market.

Answer 1

Answer:

The NPV of going directly to market is  $ 21,600,000 .

The NPV of test marketing before going to market is $26,408,571

Explanation:

In order to calculate the NPV of going directly to market we would have to calculate the Expected Present Value of Payoff

Expected Present Value of Payoff = $34,800,000*40% + $12,800,000*(1-40%)

Expected Present Value of Payoff= $ 21,600,000

The NPV of going directly to market is  $ 21,600,000

In order to calculate the NPV of test marketing before going to the market we would have to use make the following calculation:

NPV = -Initial cost in Testing + PV of Expected Present Value of Payoff in one year

Therefore, NPV = -$1,380,000 + ($34,800,000*70% + $12,800,000*(1-70%))/(1+12%)

NPV = $26,408,571

The NPV of test marketing before going to market is $26,408,571