Problem: The Whiskey Company is calculating a proposal to distil and manufacture diet scotch. Before investing in full scale production of new product, diet scotch will first be test marketed for 2 years in Maine at an immediate upfront cost of $750000. Test marketing the product is not anticipated to generate any profits but will reveal the strength of consumer preferences for diet scotch. There is only 40% chance which demand will be satisfactory, in which case Whiskey Co will spend $10 million to launch national distribution of the diet scotch, which would generate anticipated yearly profits of $1,500,000 in perpetuity. When demand is not satisfactory, the distillation and production of diet scotch will be terminated instantaneously. Once consumer preferences are known, the risk of the product cash flows will be close to the average risk level for Whiskey Co's existing products,
Question1. Which have the required return of 10%? However, Whiskey Co's CFO is convinced that the initial test market phase is much riskier than normal.
Question2. Supposing the Whiskey Co's demand a return of 35% percent on test marketing phase of new products,
Question3. Find out the NPV of decision to test market diet scotch?