B&B has a new baby powder ready to market. If the firm goes directly to the mark

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 65 percent chance of success. However, the firm can conduct customer segment research, which will take a year and cost $1.16 million. By going through research, the company will be able to better target potential customers and will increase the probability of success to 80 percent. If successful, the baby powder will bring a present value profit (at time of initial selling) of $18.6 million. If unsuccessful, the present value payoff is only $5.6 million. The appropriate discount rate is 13 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

Explanation / Answer

Immediate Sale:

65 % chance of success with present value payoff of $ 18.6 million and 35% chance of failure with present value payoff of $ 5,6 million.

Expected NPV = 0.65 x 18.6 + 0.35 x 5.6 = $ 14.05 million or 14050000

Market Research:

Research Cost (assumed to be incurred immediately) = $ 1.16 million

80% chance of succes with payoff of $18.6 million and 20% chance of failure with payoff of $5,6 million at the end of Year 1.

Expected PV at the end of Year 1 = 0.8 x 18.6 + 0.2 x 5.6 = $ 16 million

Discount Rate = 13 %

Expected PV at present = 16 / 1.13 = $ 14.16 million

NPV = 14.16 - 1.16 = $ 13 million or 13000000

As the NPV is greater in case of immediate sale, the firm should start selling immediately.

NOTE: Even if the research cost is assumed to be incurred at the end of Year 1, the NPV = (16/1.13) - (1.16/1.13) = $ 13.13 million or 13130000 which is lower than the NPV of immediate sale. Hence, the decision would have remained the same.

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