Question

Ang Electronics, Inc., has developed a new DVDR. If the DVDR is successful, the present value of the payoff (when the product is brought to market) is $33.9 million. If the DVDR fails, the present value of the payoff is $11.9 million. If the product goes directly to market, there is a 40 percent chance of success. Alternatively, Ang can delay the launch by one year and spend $1.29 million to test market the DVDR. 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.

Answer 1

If the product is successful the present value of pay-off is $33.9million.

If the product is unsuccessful the present value of the payoff is $11.9 million

Now if the product goes directly to the market success rate is 40% while failure rate will be 60% (100-40) %

So Net total value of the pay –off = 33.9*40% + 11.9*60% = $20.70million

So if the firm goes directly to the market now net pay-off would be $20.70million.

Again, if the company waits for a year,

Expenditure would be $1.29million

Success rate jumps to 70% while failure rate remains at (100-70= 30) %. So, Net total pay-off would be = -$1.29 + ($33.9*0.7 + $11.9*0.3)/ (1.1) = -$1.29 + $24.82 = $23.53.

So if it waits for a year the net pay-off ($23.53 million) > than the net pay-off if it directly goes to the market now ($20.70 million).

Hence Ang Electronics, Inc. should wait for a year.