Question

Innova has developed a new smart watch. If the watch is successful, the present value of the payoff (at the time the product is brought to market) is $32 million. If the equipment fails, the present value of the payoff is $8 million. If the watch goes directly to market, there is a 50 percent chance of success. Alternatively, Innova can delay the launch by one year and spend $2.4 million to test-market the watch. Test-marketing would allow the firm to improve the watch and increase the probability of success to 75%. The appropriate discount rate is 10%. Should the firm conduct test-marketing?

		No, because NPV at t=0 is lower by $1.15 million
		No, because NPV at t=0 is lower by $1.27 million
		Yes, because NPV at t=0 is higher by $1.24 million
		D. Yes, because NPV at t=0 is higher by $1.48 million
		E. Yes, because NPV at t=0 is higher by $1.51 million

Answer 1

NPV at t=0 is

32×50%+ 8×50%= 20 million

As there is 50per chance of success and 50% chance of failure and payoff if success is 32 million of payoff if failure is 8 million

If project is delayed 1 year for market watch

We will first caluculate NPV at t= 1

32×75%+8×25%-2.4=23.6million

As if delayed success rate will be 75% and we have to incurr an excess cost of 2.4 million

Now we will discount payoff at t=1 to t=0

Discount rate is 10%

N.P.V at t=0 is 23.6/1.1=21.45

Test marketing should be done accepted as N.P.V at t=0 is higher by 1.4545 million