A company has developed a new product.

It needs to decide whether or not to product test and market test before launch, and has been advised that, even though these processes do cost money, they increase the likelihood of success for the product. (Note that it has been agreed within the company that you can only market test a product once it has passed product testing. If a product fails either test it is regarded as worthless.)

You have been able to obtain details of the costs of these testing processes, together with historical data which suggests how much the likely success of the product is enhanced by successful testing.

Launching the product will cost $150000 and the estimates of profit are as follows:

oHighly successful = $3000000

oModerately successful = $1500000

oLow level success = $1000000

oFailure = $100000.

The historic data that has been collected gives the following results:

Chance of No testing Product testing Product testing &market testing

High success 0.1 0.1 0.2

Medium success 0.2 0.4 0.45

Low success 0.4 0.4 0.3

Failure 0.3 0.1 0.05

Product testing costs $50000 and Market testing costs $100000.

Should the product fail either of these tests it is abandoned.

The probability of passing product testing is 0.8 and the probability of passing market testing is 0.9.

The alternative to this process is to sell the product design for $250000.

Q1: Calculate EV of launch without test? (30 marks)

Q2: Calculate EV of launch with product test? (30 marks)

Q3: Calculate EV of launch with product and market test? (30 marks)

Q4: What do you advise the company to do? (10 marks)