Chapter 15: Product Development Economics

1. Chapter 15: Product Development Economics Product Design and Development Fourth Edition by Karl T. Ulrich and Steven D. Eppinger Adapted from Dr. Stamper

2. General Equations for Compound Interest • Future Value: • Present Value: • Where: • F is future value • P is present value • i is interest rate (or discount rate) • n is number of periods

3. Net Present Value Comparison • NPV CostmachineA = $28,823 • NPV CostmachineB = $32,793 • CostmachineA unadjusted = $29,500 • CostmachineBunadjusted = $38,500

4. Determining the Distribution • Straight line depreciation • Declining balance depreciation • Sum–of–years-digits depreciation

5. Economic Metrics to Evaluate Projects • Return on Investment (ROI) • Payback period • Internal Rate of Return IRR spreadsheet example

6. Economic Analysis for Product Development(Ulrich and Eppinger) • Build a base-case financial model • Perform a sensitivity analysis • Use sensitivity analysis to understand project trade-offs • Consider the influence of qualitative factors on project success • Consider Uncertainty

8. Step 1: Build a Base-Case Model

9. Step 1: Build a Base-Case Model

10. Using Excel for Q4 of Year 1: Present Value of Year 3 Costs: (-2250)/(1+0.10/4)^3= -$2089 Future Value Annual interest divided by number of periods per year Payments Made Each Period Number of periods

12. Step 2: Perform Sensitivity Analysis (e.g. 20% decrease in development costs)

13. Step 2: Perform Sensitivity Analysis (e.g. 25% increase in development time)

14. Step 2: Perform Sensitivity Analysis Ulrich & Eppinger, “Product Design and Development”

15. Step 3: Use Sensitivity Analysis to Understand Project Trade-offs

16. Step 3: Use Sensitivity Analysis to Understand Project Trade-offs (estimate Trade-off Rules from sensitivity analyses) Ulrich & Eppinger, “Product Design and Development”

17. A Question: What are some situations when you might not pursue an option that presents the best NPV?

18. Step 4: Consider the Influence of Qualitative Factors • Interactions between the Project and the Firm (e.g. strategic fit, risk/liability exposure) • Interactions between the Project and the Market (e.g. competitors, customers, suppliers) • Interactions between the Project and the Macro Environment (e.g. economic shifts, government regulations, social trends) Ulrich & Eppinger, “Product Design and Development”

20. Step 5: Consider Uncertainty Modeling Uncertain Cash Flows Dealing With Risk

21. Determining NPV with probabilities. Probability that the Patent is allowed NPV= Pa*PVa + Pb*PVb = 0.6($6.5 million) + 0.4($1.5 million) = $4.5 million

22. NPV with market testing is $2,650,000