You are evaluating a product The market demand for the produ

You are evaluating a product. The market demand for the product can be low or high. The product requires an investment of $500. If the market demand is high, the product will have a payoff of $800. If the market demand is low, the product will have payoff of $340. You do not know whether the market demand is high or low, but you know the probability that the market demand will be high is 75%, and that it will be low is 25%. Given the above information, you calculate the NPV to be: (0.75*800 + 0.25*340) - 500 Now, a market research organization offers to do a survey to determine whether the demand will be high or low BEFORE you make the 500 investment. What is the value of the survey to you? That is, the maximum amount you would be ready to pay to have the survey conducted? (Your answer should be positive

Solution

Answer is $185

Working:

The maximum value is the amount which will not result in any loss to the company.

This is the value of the proposal, i.e., the NPV.

The maximum amount that can be pid for the survey = (0.75*800+0.25*340) - 500 = $185.