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 60 percent chance of success. However, the firm can conduct customer segment research, which will take a year and cost $1.3 million. By going through research, B&B 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 $20 million. If unsuccessful, the present value payoff is only $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, e.g., 1,234,567. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

Explanation / Answer

Market Research

Cash flow in year 0 = - $ 1.3 M( Investment)

If successful, PV of profits = $ 20 M (at year 1) ; NPV of success = 20/1.14 -1.3 = $ 16.24 M

If unsuccessful,PV of Profits = $7 M; NPV of not being successful = 7/1.14 - 1.3 = $ 4.84 M

NPV of undertaking Market research = 0.75* 16.24 + 0.25 * 4.84 = $ 13.39 M

Market Immediately

If successful, NPV of profit= $ 20 M

If not successful, NPV = $ 7 M

NPV of going to market immediately = 20*0.6 + 7 * 0.4 = $ 14.8 M

As NPV of going to market is more , the firm should go to market immediately.

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