Should the Firm Conduct Test Marketing Before Going to Market?

Calculation of NPV for Going Directly to Market and Test Marketing Before Going to Market

Ang Electronics, Inc., has developed a new DVDR with a potential successful payoff of $34.5 million and a failure payoff of $12.5 million. There is a 40% chance of success if the product goes directly to market. Alternatively, the company can conduct test marketing for $1.35 million, which would increase the probability of success to 70%.

NPV of Going Directly to Market:

First, calculate the probability of failure:
Probability of failure = 100% - 40%
Probability of failure = 60%

NPV of going directly to market = 60% * $34,500,000 + 40% * $12,500,000
NPV of going directly to market = $20,700,000 + $5,000,000
NPV of going directly to market = $25,700,000

NPV of Test Marketing Before Going to Market:

Calculate the probability of failure:
Probability of failure = 100% - 70%
Probability of failure = 30%

Calculate Year 1 value:
Year 1 value = 70% * $34,500,000 + 30% * $12,500,000
Year 1 value = $24,150,000 + $3,750,000
Year 1 value = $27,900,000

Calculate NPV of test marketing before going to market:
NPV of test marketing before going to market = $27,900,000 / (1 + 12%) - $1,350,000
NPV of test marketing before going to market = $24,910,714.29 - $1,350,000
NPV of test marketing before going to market = $23,560,714.29

Based on the above calculations, the NPV of going directly to market is higher than conducting test marketing before going to market. Therefore, the firm should NOT conduct test marketing before bringing the product to market.