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 $34.7 million. If the DVDR fails, the present value of the payoff is $12.7 million. If the product goes directly to market, there is a 60% chance of success. Alternatively, the company can delay the launch by one year and spend $1.37 million to test market the DVDR. Test marketing would allow the firm to improve the product and increase the probability of success to 90%. The appropriate discount rate is 10%. Calculate the NPV of going directly to market and the NPV of test marketing before going to market.

Answer 1

NPV = Total value of expected payoff

NPV = $34,700,000*60% + $12,700,000*(1-60%)

NPV = $20,820,000 + $5,080,000

NPV = $25,900,000

Hence, the NPV of going directly to the market is $25,900,000

NPV = PV of expected payoff after year - Initial testing cost

NPV = $34,700,000*90% - $12,700,000*(1-90%)/(1+10%) - $1,370,000

NPV = $32,500,000 / 1.10 - $1,370,000

NPV = $15,845,454.55

Hence, the NPV of test marketing before going to market is $15,845,454.55