Ang Electronics, Inc., has developed a new DVDR. If the DVDR is successful, the
ID: 2782288 • Letter: A
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 $33.9 million. If the DVDR fails, the present value of the payoff is $11.9 million. If the product goes directly to market, there is a 40 percent chance of success. Alternatively, Ang can delay the launch by one year and spend $1.29 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 $
Explanation / Answer
We need to calculate the NPV of the two options:
Go directly to market now, or utilize test marketing first.
The NPV of going directly to market now is:
NPV = CSuccess * (Prob. of Success) + CFailure * (Prob. of Failure)
NPV = $33,900,000 * (0.40) + $11,900,000 * (0.60)
NPV = $20,700,000
Now we can calculate the NPV of test marketing first.
Test marketing requires a $1.29 million cash outlay.
Choosing the test marketing option will also delay the launch of the product by one year. Thus, the expected payoff is delayed by one year and must be discounted back to Year 0.
NPV = C0 + (CSuccess * (Prob. of Success) + CFailure * (Prob. of Failure)) / (1 +R)t
NPV = –$1,290,000 + ($33,900,000 * (0.70) + $11,900,000 * (0.30)) / 1.12
NPV = –$1,290,000 + 27,300,000/ (1.12)
NPV = –$1,290,000 + 24,375,000
NPV = 23,085,000
The company should test market first since that option has the highest expected payoff