Ang Electronics, Inc., has developed a new HD DVD. If the HD DVD is successful,

Question

Ang Electronics, Inc., has developed a new HD DVD. If the HD DVD is successful, the present value of the payoff (at the time the product is brought to market) is $34.3 million. If the HD DVD fails, the present value of the payoff is $12.3 million. If the product goes directly to market, there is a 50 percent chance of success. Alternatively, Ang can delay the launch by one year and spend $1.33 million to test-market the HD DVD. Test-marketing would allow the firm to improve the product and increase the probability of success to 80 percent. The appropriate discount rate is 11 percent. Calculate the NPV of going directly to market and the NPV of test-marketing before going to market. Should the firm conduct test-marketing?

Explanation / Answer

Part A)

The NPV of going to the market now can be calculated with the following formula:

NPV = Present Value in Case of Success*(Probability of Success) + Present Value in Case of Faliure*(Probability of Faliure)

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Here, Present Value in Case of Success = $34,300,000, Probability of Success = 50%, Present Value in Case of Faliure = $12,300,000 and Probability of Faliure = 50%

Using these values in the above formula, we get,

NPV = 34,300,000*50% + 12,300,000*50% = $23,300,000

___________

The test marketing option would result in a delay in the launch of the product. In order to calculate the present value, we will have to discount the cash flows occuring at the end of the year to today's value. The NPV of test marketing can be calculated with the use of following formula:

NPV = -Cash Outlay + [(Present Value in Case of Success*(Probability of Success) + Present Value in Case of Faliure*(Probability of Faliure)]/(1+Discount Rate)

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Here, Cash Outlay = $1,330,000, Present Value in Case of Success = $34,300,000, Probability of Success = 80%, Present Value in Case of Faliure = $12,300,000 and Probability of Faliure = 20%

Using these values in the above formula, we get,

NPV = -1,330,000 + [(34,300,000*80% + 12,300,000*20%)]/(1+11%) = $25,606,937

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Tabular Representation

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Part B)

Yes, the firm should conduct test marketing first, as it results in more NPV.

NPV Go to Market Now $23,300,000 Test Marketing First $25,606,937

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