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 $33.2 million. If the HD DVD fails, the present value of the payoff is $11.2 million. If the product goes directly to market, there is a 50 percent chance of success. Alternatively, the company can delay the launch by one year and spend $1.22 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.

Answer 1

Given the following information

Payoff:

Success $ 33.20

Failure $ 11.20

Probability of success and failue if product directly goes to market

Success 0.5

Failure 0.5

Probability of success and failue if the test marketing before go to market

Success 0.8

Failure 0.2

Cost for test market $ 1.22

NPV of going directly to market

Payoff = (33.2 × 0.5) +(11.2 × 0.5) = $ 22.20

NPV = 22.20/(1+0.11) = $ 20

NPV of going to market after test market

Payoff = [(33.2 - 1.22) × 0.8] + [(11.2 -1.22)×0.2] = $27.58

NPV = 27.58/(1+0.11)² = $ 22.38