Chapter 8: Strategy and Analysis in Using Net Present
Value
Concept Questions - Chapter 8
8.1 What are the ways a firm can create positive NPV.
1.Be first to introduce a new product.
2.Further develop a core competency to product goods
or services at lower costs than competitors.
3.Create a barrier that makes it difficult for the
other firms to compete effectively.
4.Introduce variation on existing products to take
advantage of unsatisfied demand
5.Create product differentiation by aggressive
advertising and marketing networks.
e innovation in organizational processes to do
all of the above.
How can managers use the market to help them screen out negative NPV projects?
8.2 What is a decision tree?
It is a method to help capital budgeting decision-
makers evaluating projects involving sequential
decisions. At every point in the tree, there are
different alternatives that should be analyzed.
What are potential problems in using a decision tree?
Potential problems 1) that a different discount rate should be used for different branches in the tree
and 2) it is difficult for decision trees to capture managerial options.
8.3 What is a sensitivity analysis?
It is a technique used to determine how the result
of a decision changes when some of the parameters or assumptions change.
Why is it important to perform a sensitivity analysis?
Because it provides an analysis of the consequences
of possible prediction or assumption errors.
What is a break-even analysis?
It is a technique used to determine the volume of
production necessary to break even, that is, to
cover not only variable costs but fixed costs as
well.
Describe how sensitivity analysis interacts with break-even analysis.
Sensitivity analysis can determine how the financial break-even point changes when some factors (such as
fixed costs, variable costs, or revenue) change.
Answers to End-of-Chapter Problems
QUESTIONS AND PROBLEMS
Decision Trees
8.1 Sony Electronics, Inc., has developed a new type of VCR. If the firm directly goes to the market with the product, there is only a 50 percent chance of success. On the other hand, if the firm conducts test marketing of the VCR, it will take a year and will cost $2 million.
Through the test marketing, however, the firm is able to improve the product and increase the probability of success to 75 percent. If the new product proves successful, the present value (at the time when the firm starts selling it) of the payoff is $20 million, while if it turns out to be a failure, the present value of the payoff is $5 million. Should the firm conduct test marketing or go directly to the market? The appropriate discount rate is 15 percent.
8.1 Go directly:
NPV = 0.5 $20 million + 0.5 $5 million
= $12.5 million
Test marketing:
NPV = -$2 million + (0.75 $20 million + 0.25 $5 million) / 1.15
= $12.13 million
Go directly to the market.
8.2 The marketing manager for a growing consumer products firm is considering launching a new product. To determine consumers’ interest in such a product, the manager can conduct a focus group that will cost $120,000 and has a 70 percent chance of correctly predicting the success of the product, or hire a consulting firm that will research the market at a cost of $400,000. The consulting firm boasts a correct assessment record of 90 percent. Of course going directly to the market with no prior testing
will be the correct move 50 percent of the time. If the firm launches the product, and it is a success, the payoff will be $1.2 million.
Which action will result in the highest expected payoff for the firm?
8.2 Focus group: -$120,000 + 0.70 $1,200,000 = $720,000
Consulting firm: -$400,000 + 0.90 $1,200,000 = $680,000
Direct marketing: 0.50 $1,200,000 = $600,000
The manager should conduct a focus group.
8.3 Tandem Bicycles is noticing a decline in sales due to the increase of lower-priced import products from the Far。