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 $34.4 million. If the HD DVD fails, the present value of the payoff is $12.4 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 $1.34 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?

• No

• Yes

Answer 1

Compuatation of NPV of going directly to market -

P_s = Probability of success = 60% = 0.60

P_f = Probability of failure = 100%- 60% = 40% = 0.40

PV_s = Present value of success = $34,400,000

PV_f = Present value of failure = $12,400,000

NPV = Present value of cash inflows - Present value of cash outflows

NPV = [(P_s x PV_s) + (P_f x PV_f)] - Present value of cash outflows

NPV = [(0.60 x 34,400,000) + (0.40 x 12,400,000)] - 0

NPV = 20,640,000 + 4,960,000

NPV = 25,600,000

Compuatation of NPV of test marketing -

P_s = Probability of success = 90% = 0.90

P_f = Probability of failure = 100% - 90% = 10% = 0.10

PV_s = Present value of success = $34,400,000

PV_f = Present value of failure = $12,400,000

Present value of cash outflows = $1,340,000

r = Discount rate = 10% = 0.10

NPV = Present value of cash inflows - Present value of cash outflows

NPV = {[(P_s x PV_s) + (P_f x PV_f)] / (1 + r)} - Present value of cash outflows

NPV = {[(0.90 x 34,400,000) + (0.10 x 12,400,000)] / (1 + 0.10)} - 1,340,000

NPV = {(30,960,000 + 1,240,000) / 1.10} - 1,340,000

NPV = {32,200,000 / 1.10} - 1,340,000

NPV = 29,272,727 - 1,340,000

NPV = 27,932,727

Since the NPV of test marketing is much higher, YES, the firm should conduct test marketing.