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 $34.5 million. If the DVDR fails, the present value of the payoff is $12.5 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 $1.35 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. (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 $
Test marketing first $
Should the firm conduct test marketing?
No
Yes

Answer 1

Answer:

1. NPV Go to market now $25,700,000

2. NPV Test marketing first $23,560,714.29

No

Explanation:

1. Calculation to determine the NPV of going directly to market

NPV OF GOING DIRECTLY TO MARKET:

First step is to calculate the Probability of failure

Probability of failure = 100% - 40%

Probability of failure = 60%

Now let calculate the NPV of going directly to market

NPV of going directly to market = 60% * $34,500,000 + 40% * $12,500,000

NPV of going directly to market=$20,700,000+$5,000,000

NPV of going directly to market = $25,700,000

Therefore NPV of going directly to market is $25,700,000

2 Calculation to determine the NPV Test marketing before going to market:

NPV TEST MARKETING BEFORE GOING TO MARKET:

First step is to calculate the Probability of failure

Probability of failure = 100% - 70%

Probability of failure =30%

Second step is to calculate Year 1 value

Year 1 value = 70% * $34,500,000 + 30% * $12,500,000

Year 1 value=$24,150,000+$3,750,000

Year 1 value = $27,900,000

Now let calculate the NPV of test marketing before going to market

NPV of test marketing before going to market = $27,900,000 /(1 + 12%) - $1,350,000

NPV of test marketing before going to market =$24,910,714.29-$1,350,000

NPV of test marketing before going to market= $23,560,714.29

Therefore NPV of test marketing before going to market is $23,560,714.29

NO. Based on The above calculation the firm should NOT conduct test marketing before going to market reason been that the NPV is lower.