net present value analysis

[winw]

Hi,

I'm confused about this problem

Baron industries has developed a new product that they hope to bring to market soon, however, not all the bugs have been worked out. If the product is launched today, and is a success, it is expected to have a net present value of +3000. However, there is a 10% probability that a recall may be forced a year later. If this is the case then the net present value will decrease to -100. Baron industries could delay the project by one or two years to improve the quality of the product. If the project is delayed by one year, the probability of recall falls to 1%, if the project is delayed by two years then the probably of recall falls to 0.1%. At which point in time should the product be launched.

This is what I have

today 3000(0.90)-100(0.10)=2690

delay one year 3000(0.99)-100(0.01)=2969

delay two years 3000(0)-100(0.001)=2996

delay the project by two years would provide the highest net present value

Thank you for your help

 

[winw]

I am confused by the problem statement. As you have stated it, there is no unsolved issue of present value. It is purely a problem in comparing expected values. So if you have correctly summarized the problem, you have solved it almost correctly.

I suspect, however, that this problem concerns expected present value. Are those present values as of the launch date? If so, the present value problem remains unsolved because the present values that you have used to calculate expected value refer to different dates. In that case, the problem statement should be giving you one or more interest rates to work with. And are the present values for the same date or different dates?

The problem does not explicitly say but according to my understanding of what we did in class, its like 2 cases of what might happen, good or bad. I think that the net present values refer to the same time (t=0) and not the launch date.

 

[winw]

If your understanding is correct, then you merely need to fix that tiny arithmetic error I pointed out. You have the concept.

Do not be surprised, however, if your understanding turns out to be in error. It is not a very realisitic problem to get the same present value from a successful launch regardless of whether that launch is now, a year from now, or two years from now. If the problem statement has an interest rate (or two interest rates) in it, I'd definitely be worried that you have somehow misunderstood the problem. Obviously you do not need an interest rate if all the present values refer to the same date, namely now.

Ok, thank you for your help. The problem does not have any additional information, maybe we are starting off easy.