NEW PRODUCT INTRODUCTION

Dec-Soft Technologies is a software development company that offers an array of

inexpensive PC-based decision-support solution products. These products are targeted for
small-size companies that cannot afford the customized, high-end versions offered by
majors like i-2 Technologies, SAP and so on. Gautam is the “brain” at Dec-Soft who is
constantly coming up with new ideas. Well, he has come up with a new product idea yet
again! The question is should this idea be considered seriously?

The product development cost for this idea is estimated to be $500,000. The market for
this product can be expected to last only four years. It is expected that the product will be
priced at $100. There is a small variable cost which includes the cost of making the
product CD, packaging and shipping, which is expected to follow a normal distribution
with a mean of $20 and a standard deviation of $3. The annual fixed cost is estimated to
be about $400,000 with a 10% variation. This fixed cost comprises mainly of the cost of
marketing and after sales service. It is expected that each value cost across this range has
an approximately equal chance of occurrence. It is important to understand that the fixed
cost should be about the same each year. It is just that we do not know for sure what it
will be. Sales volume in the first year will follow a triangular distribution with a
minimum of 500 units, a mode of 6,000 units, and a maximum of 24,000 units. Sales
volumes from year two to year four will be some fraction of the previous years.
Specifically, the sales in a given year will be some fraction of the sales in the previous
year. However, the fraction will vary randomly. Further, the fraction in a given year will
be independent of the fraction of other years. The fractions are expected to follow a
truncated normal distribution with a mean of 0.9 and a standard deviation of 0.1.
Basically, the first year will reveal broadly the extent of the demand for this product.
Ignore taxes and use a hurdle rate of 10%.

Discussion Questions:

Should Dec-Soft develop and introduce this product?

What is the chance that this product will lose money?

What are the sources of risk?

Suppose that the firm has the option of bailing out after the first year with no damage to
the firm’s reputation. Will this option change the profitability of this product? Will it
reduce risk? If so, then how?