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					   Product Development
   Economics




Fall 2009      ECEN 490   1
Homework Assignments
       Determine how much you will pay in total
        for a car costing $10,000 which you
        finance at 5% for 5 years.

       Using the PMT function in Excel =
        $11,322.74. But you will actually pay 59
        payments of $188.71, and 1 payment of
        $188.85 .

       Why a different final payment?
Fall 2009                ECEN 490                  2
Project - Economic Evaluations
               Concept   System-Level        Detail   Testing and   Production
  Planning
             Development    Design           Design   Refinement     Ramp-Up




                Go/No-Go Decision Gates
                Sensitivity and Trade-off Analysis



Fall 2009                         ECEN 490                                   3
   Product Development
   Cash Flow                                 Sales Revenue
                                             Operating Costs
       +                                     Operating Profit



            $’s                                 Net Profit




                                             Investment
            -     Development
                     Time
                                Payback
                                 Time
                         Break Even
                            Time
                                                             Time


Fall 2009                         ECEN 490                      4
Inputs for Economic Analysis
       Initial   Expenses
            Development   cost and timing
            Testing cost and timing
            Tooling investment and timing
            Ramp-up cost and timing
            Marketing and support cost and
             timing

Fall 2009                  ECEN 490           5
Inputs for Economic Analysis
           Ongoing Expenses
             Marketing cost and timing
             Product support cost and timing
             Unit production cost
             Displaced product revenue
           Ongoing Income
             Unitrevenue
             Sales volume and lifetime
           Discount rate
             Costof acquiring money in the
              company
Fall 2009                    ECEN 490           6
   What is money worth?
     You give me $50 this year and I will give
      it back in a year?
        No   interest
     You give me $50 this year and I will give
      you $53 next year?
        Accrued   interest
     You give me $47 this year and I will give
      you $50 next year?
        Discounted      interest

Fall 2009                      ECEN 490           7
Net Present Value

            NPV =   S
                periods
                          period cash flow
                          (1 + discount rate)
                                                    period




                           S
                            N           Ci
                NPV =                 (1 + r)
                                                i
                           i =1




Fall 2009                  ECEN 490                          8
Net Present Value Example
                                         S
                                           N          Ci
                         NPV =                      (1 + r)
                                                              i
                                         i =1

                    •100 Dollars per year for the next 5 years
                    •6% interest (discount rate)


        NPV = 100/(1.06) + 100/(1.06)2 + 100/(1.06)3 + 100/(1.06)4 + 100/(1.06)5
        NPV = 100/1.06 + 100/1.12 + 100/1.19 + 100/1.26 + 100/1.34
        NPV = $421.24




Fall 2009                                ECEN 490                                  9
Project Financial Analysis
 Most   companies use NPV analysis of
  project cash flows.
 First, compute base model NPV
  projection.
 Sensitivity and trade-off analysis
  supports development decisions.
 Qualitative factors also influence
  decisions.
Fall 2009         ECEN 490               10
Qualitative Factors
 Project technology has application to other
  future projects
 Keep product line current
 Comprehensive product line
 Support or auxiliary products
 Potential breakthrough technology
 The boss likes it
 etc.
Fall 2009           ECEN 490                11
   What is money worth?
     Bank Interest 5-6%
     Corporate Earning Rate 10-12%
     Marginal Rate for new projects 10-18%
       Why    would Marginal rate be higher?

       Riskof new development
       Other opportunities for use of funds.



Fall 2009               ECEN 490                12
PDA High Capacity Disk Drive

            Should we develop a new PDA
                     attachment?




Fall 2009              ECEN 490           13
   Inputs for New Disk Drive
   Base Case analysis
               Development cost and timing
                          $1.8million, 18 months
               Testing cost and timing
                          $400K, 1 year
               Tooling investment and timing
                          $250k, 6 months
               Ramp-up cost and timing
                          $150k, 6 months
               Marketing and support cost and timing
                          $250k + $80k/year for product life
               Sales volume and lifetime
                          200k units/year, lifespan 2.5 years= 500k units
               Unit production cost
                          $44/unit + $2/unit overhead
               Unit revenue
                          $56/unit wholesale
               Discount rate
                          10%/year

Fall 2009                          ECEN 490                                 14
Back of the envelope calculation

500,000 units at $56/unit =         $28,000,000
Cost of 500,000 units at $46/unit = $23,000,000
Gross profit                         $5,000,000

Invest $2.6M to make $5M -- sounds good to me.

But………
What did we leave out?
 Marketing expenses of $ 250K + $80K per year
 Time value of money
 Fall 2009              ECEN 490                  15
    Go to the Excel Spreadsheet example




Fall 2009           ECEN 490              16
Rule of 78
 The rule of 78 says, that you can divide 78 by the yearly
 interest rate and that will tell you how long it will take for you
 money to double at that interest rate.

 For Example if you are getting 3% on your money in a savings
 account it will take you 26 (78/3) years to double your money.

 If you can get 12% how long will it take?




Fall 2009                       ECEN 490                              17
What to Remember
 Financial analysis is driving product
  development decisions
 Be supportive of ridiculously early requests
  for development costs, intervals, product
  costs, etc.
 Economics can help drive your design
  decisions
       Product development time versus product cost
       Custom development, tooling, test fixtures
        versus product cost

Fall 2009                ECEN 490                 18
Personal economics
 What ways do companies compensate
  employees?
 Salary
 Bonuses
 Stock options.




Fall 2009        ECEN 490             19
Stock Options
 What are they?
         They provide the legal right to buy stock
          at a specific price (independent of the
          current market)
         Options usually have a time window
             Only after a specific date—usually a
              percentage each year.
             Expiration date—usually 5 years



Fall 2009                   ECEN 490                 20
    Stock Options
     Example
 Option to buy 500 shares of XYZ Corp at
  $24 per share
 If XYZ shares are at $30 per share
       Make   $3000 today (30-24*500)
       Wait till tomorrow and make $3500 (or $2000)

   If XYZ shares fall to $23.75 per share
       Worth   nothing
       Wait till tomorrow

Fall 2009                    ECEN 490              21
   Stock Options
     Key Factors
           Most options are given out at prices at
            the current market value
             Market $18 per share
             Option price $18 per share

           Most option have a waiting period
            1 to 2 years
             When (If) the company goes public

           Most options terminate with employment

Fall 2009                    ECEN 490                 22
   Stock Options
   Employment Considerations
       You get a job offer from TeenyTiny
        Electronics
       Offer is $6000 per year less than Intel
       Offer includes 7500 options at $12 per
        share (exercise 6 months after public
        offering)
       Is this a good economic offer?


Fall 2009               ECEN 490                  23
Homework assignment -Mar. 5th
 Design a test procedure that you will use
  to validate one of the key project
  specifications that you identified in your
  FSD.
 Email a description of the test, and if you
  are at a stage to actually run the test, also
  include the test results.

Fall 2009            ECEN 490                 24
      If you believe that the stock will be
      at $20 per share in a couple of
      years, then you may want to
      consider the job offer. (8*7500=
      $60,000)




Fall 2009             ECEN 490                25

				
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