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 $33 million. If the HD DVD fails, the present value of the payoff is $11 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 $1.2 million to test-market the HD DVD. 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. (DO NOT ROUND ANSWER!!!!!)

Should the firm conduct test marketing?

Answer 1

Solution:-

First we calculate NPV of Going Directly to Market Now -

NPV = Present Value of Success * Probability of Success + Present Value of Failure * Probability of Failure

NPV = 33,000,000 * 0.40 + 11,000,0000 * 0.60

NPV = $1,98,00,000

To Calculate NPV of test Marketing First -

Initial outlay are given in question and cash inflow are delayed by one year so discounted by one year.

NPV = Present Value of Cash Inflow - Present Value of Cash outflow.

NPV = (33,000,000 * 0.70 + 11,000,000 * 0.30)/(1.12) - 12,00,000

NPV = (23,100,000 + 33,00,000)/1.12 - 12,00,000

NPV = $22,371,428.57

So Company should go for Test Marketing first as highest NPV then Going Directly to Market.

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