The manager for a growing firm is considering the launch of a new product. If the product goes directly to market, there is a 40 percent chance of success. For $171,000, the manager can conduct a focus group that will increase the product’s chance of success to 55 percent. Alternatively, the manager has the option to pay a consulting firm $386,000 to research the market and refine the product. The consulting firm successfully launches new products 70 percent of the time. If the firm successfully launches the product, the payoff will be $1.86 million. If the product is a failure, the NPV is zero.


Calculate the NPV for each option available for the project

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To calculate the NPV (Net Present Value) for each option available for the project, we need to consider the probabilities and payoffs associated with each option.

Let's calculate the NPV for each option:

Option 1: Launch the product directly to market (40% chance of success)
- Probability of success: 40%
- Payoff if successful: $1.86 million
- NPV if successful: $1.86 million
- NPV if failure: $0

We calculate the total NPV for Option 1 as follows:
NPV = (Probability of success * Payoff if successful) + (Probability of failure * NPV if failure)
NPV = (0.40 * $1.86 million) + (0.60 * $0)
NPV = $0.744 million + $0 = $0.744 million

Option 2: Conduct a focus group (55% chance of success)
- Probability of success: 55%
- Payoff if successful: $1.86 million
- Cost of conducting focus group: $171,000
- NPV if successful: $1.86 million - $171,000
- NPV if failure: $0

We calculate the total NPV for Option 2 as follows:
NPV = (Probability of success * (Payoff if successful - Cost of conducting focus group)) + (Probability of failure * NPV if failure)
NPV = (0.55 * ($1.86 million - $171,000)) + (0.45 * $0)
NPV = $0.909 million + $0 = $0.909 million

Option 3: Pay consulting firm for market research (70% chance of success)
- Probability of success: 70%
- Payoff if successful: $1.86 million
- Cost of consulting firm: $386,000
- NPV if successful: $1.86 million - $386,000
- NPV if failure: $0

We calculate the total NPV for Option 3 as follows:
NPV = (Probability of success * (Payoff if successful - Cost of consulting firm)) + (Probability of failure * NPV if failure)
NPV = (0.70 * ($1.86 million - $386,000)) + (0.30 * $0)
NPV = $1.167 million + $0 = $1.167 million

Comparing the NPVs for each option, we find:
- NPV for Option 1: $0.744 million
- NPV for Option 2: $0.909 million
- NPV for Option 3: $1.167 million

Therefore, based on the NPV analysis, Option 3 (paying the consulting firm for market research) has the highest potential net present value and is the recommended option for the project.