Question
Your firm is proposing to market a new product. First, the product will be test-marketed for two years at an initial cost of $1,000,000. The
Your firm is proposing to market a new product. First, the product will be test-marketed for two years at an initial cost of $1,000,000. The test marketing is not expected to produce any profits but should reveal the preference of the consumers. There is a 60% chance that the test marketing will be successful. if successful, your firm will spend an additional $10,000,000.(in 2 year from today)to launch the product more widely and will receive an expected annual (after tax) cash flow (from year 3 ) of $1,400,000 in perpetuity. However, if the test marketing is not successful, the product will be withdrawn.
Once the preferences of the consumers are revealed, the product will be subject to normal risk. Your firm require a return of 10% for normal risk projects. However, the initial test-marketing phase is viewed as much riskier and your firm requires a return of 50% on such expenditures. Compute the NPV for the new product.
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