Question

B&B has a new baby powder ready to market. If the firm goes directly to the market with the product, there is only a 60 percent chance of success. However, the firm can conduct customer segment research, which will take a year and cost $1.17 million. By going through research, the company will be able to better target potential customers and will increase the probability of success to 75 percent. If successful, the baby powder will bring a present value profit (at time of initial selling) of $18.7 million. If unsuccessful, the present value payoff is only $5.7 million. The appropriate discount rate is 14 percent. Calculate the NPV for the firm if it conducts customer segment research, and if it goes to market immediately. (Enter your answers in dollars, not millions of dollars. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 1,234,567.89.) NPV $ Market immediately Research option $ Should the firm conduct customer segment research or go to the market immediately? Market immediately Conduct research

Answer 1

Solution :

The NPV of going to the market immediately is = $ 13,500,000.00

The NPV of the research option is = $ 12,382,631.58

Since the NPV of the option to go to the market immediately is higher, the company should go to the market immediately.

Please find the attached screenshot of the excel sheet containing the detailed calculation for the solution.

16.07.2020 - Excel File Home Insert Page Layout Formulas Data Review View Help Tell me what you want to do А. B C D E F G H - 1 2 3 4 Statement showing calculation of NPV of going to the market immediately Sl.No. Particulars Cash Inflows Probability (1) (2) 1 Present value of profit/ payoff if the product i.e., Baby Powder is a success $ 18,700,000.00 60.00% 2 Present value of profit /payoff if the product i.e., Baby Powder is a failure $ 5,700,000.00 40.00% 3 NPV of directly going to the market immediately ESUM(G4:G5) Probable cash flows (3) = (1) * (2) $ 11,220,000.00 $ 2,280,000.00 $ 13,500,000.00 5 6 7 8 9 Statement showing calculation of NPV of the research option Sl.No. Particulars Cash flows Year PVF @ 14 % Discounted Cash (1) (2) flows (3) = (1) * (2) 1 Present value of profit/ payoff if the product i.e., Baby Powder is a success $ 18,700,000.00 1 0.8772 $ 16,403,508.7719 2 Present value of profit /payoff if the product i.e., Baby Powder is a failure 5,700,000.00 0.8772 $ 5,000,000.0000 3 Total of Probable cash Inflows of the Research Option - (A) 4 Less : Initial Investment $ 1,170,000.00 이 1.0000 $ 1,170,000.00 5 Cash Outflows of the Research Option - (B) 6 NPV of the Research Option = (A) - (B) 7 NPV of the Research Option (Rounded off to two decimal places) 1 10 11 12 13 14 15 16 17 18 19 20 Probability Probable discounted (4) cash flows (5) = (3) * (4) 75.00% $ 12,302,631.5789 25.00% $ 1,250,000.0000 13,552,631.5789 100.00% $ 1,170,000.0000 $ 1,170,000.0000 $ 12,382,631.5789 $ 12,382,631.58 $