Question

The manager for a growing firm is considering the launch of a new product. If the product goes directly to market, there is a 40 percent chance of success. For $180,000 the manager can conduct a focus group that will increase the product’s chance of success to 55 percent. Alternatively, the manager has the option to pay a consulting firm $395,000 to research the market and refine the product. The consulting firm successfully launches new products 70 percent of the time. If the firm successfully launches the product, the payoff will be $1.95 million. If the product is a failure, the NPV is zero.

Calculate the NPV for each option available for the project. (Do not round intermediate calculations. Enter your answers in dollars, not millions of dollars, e.g., 1,234,567, rounded to the nearest whole number, e.g., 32.)

	NPV
Go to market now	$
Focus group	$
Consulting firm	$

   

Which action should the firm undertake?

	Go to market now
	Consulting firm
	Focus group

Answer 1

a)

Go to market now:

NPV = Probability of success * payoff

NPV = 0.4*1,950,000

NPV = $780,000

Focus group:

NPV = -focus group expense + probability of success* payoff

NPV = -180,000 + 0.55*1,950,000

NPV = -180,000 + 1,072,500

NPV = 892,500

Consulting firm:

NPV = -consulting fee + probability of success* payoff

NPV = -395,000 + 0.7*1,950,000

NPV = -395,000 + 1,365,000

NPV = 970,000

b)

The firm should go with CONSULTING FIRM option since it has the highest NPV