Question

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

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 \$33.7 million. If the HD DVD fails, the present value of the payoff is \$11.7 million. If the product goes directly to market, there is a 60 percent chance of success. Alternatively, the company can delay the launch by one year and spend \$1.27 million to test-market the HD DVD. Test-marketing would allow the firm to improve the product and increase the probability of success to 90 percent. The appropriate discount rate is 10 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. Do not round intermediate calculations and round your answers to nearest whole dollar amount, e.g., 1,234,567.)

 NPV Go to market now \$ Test-marketing first \$

Should the firm conduct test-marketing?

• Yes

• No

Homework Answers

Answer #1

a). The NPV of going directly to market now is:

NPV = CSuccess(Prob. of Success) + CFailure(Prob. of Failure)

= \$33,700,000(0.60) + \$11,700,000(0.40) = \$20,220,000 + \$4,680,000 = \$24,900,000

b). Test marketing requires a \$1.27 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

= –\$1,270,000 + [{\$33,700,000(0.90) + \$11,700,000(0.10)} / 1.10]

= –\$1,270,000 + [\$31,500,000 / 1.10]

= –\$1,270,000 + \$28,636,363.64 = \$27,366,363.64, or \$27,366,364

c). The company should test market first since that option has the highest expected payoff

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