Problem:
The Whiskey Company is evaluating a proposal to distill and manufacture diet scotch. Before investing in full scale production of the new porduct, diet scotch will first be test marketed for 2 years in Maine at an immediate up front cost of $750000. Test marketing the poduct is not expected to produce any profits but will reveal the strenth of consumer preferences for diet scotch. There is only a 40% chance that dema d will be satisfactory, in which case Whiskey Co will spend $10 million to launch national distributino of the diet scotch, which would generate expected yearly profits of $1,500,000 in perpetuity. If demand is not satisfactory, the distillation and production of diet scotch will be terminated immediately. Once consumer preferences are known, the risk of the product cash flows will be similar to the average risk level for Whiskey Co's existing products, which havea required return of 10%. However, Whiskey Co's CFO is convinced that the initial test market phase is much riskier than normal.
Required:
Question: Assuming the Whiskey Co's demand a return of 35% percent on the test marketing phase of new products, determine the NPV of decision to test market diet scotch?
Note: Show all workings.