ECEN 490 1 Winter 2015 Product Development Economics

ECEN 490 1Winter 2015

Product Development Economics


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 = $188.712336. But you will actually pay 59 payments of $188.71, and 1 payment of $188.85 . This is a total of $11,322.74

Why a different final payment?


Project - Economic Evaluations

PlanningPlanning ConceptDevelopment

ConceptDevelopment

System-LevelDesign

System-LevelDesign

DetailDesign

DetailDesign

Testing andRefinement

Testing andRefinement

ProductionRamp-Up

ProductionRamp-Up

Go/No-Go Decision Gates

Sensitivity and Trade-off Analysis


Product Development Cash Flow Sales Revenue

Operating Profit

Operating Costs

Break EvenTime

PaybackTime

DevelopmentTime

Time

Net Profit$’s

+

Investment

-


Inputs for Economic Analysis

Initial ExpensesDevelopment cost and timingTesting cost and timingTooling investment and timingRamp-up cost and timingMarketing and support cost and timing


Inputs for Economic Analysis Ongoing Expenses

Marketing cost and timingProduct support cost and timingUnit production cost Displaced product revenue

Ongoing IncomeUnit revenue Sales volume and lifetime

Discount rateCost of acquiring money in the company


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


Net Present Value

NPV =period cash flow

(1 + discount rate)period

periods

NPV =C

(1 + r)i

Ni

i = 1


Net Present Value Example

NPV =C

(1 + r)i

Ni

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


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.


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.


What is money worth? Bank Interest 1-3% Corporate Earning Rate 6-10% Marginal Rate for new projects 10-15%

Why would Marginal rate be higher?

Risk of new developmentOther opportunities for use of funds.


PDA High Capacity Disk Drive

Should we develop a new PDA attachment?


Inputs for New Disk Drive Base Case analysis

Development cost and timing

Testing cost and timing

Tooling investment and timing

Ramp-up cost and timing

Marketing and support cost and timing

Sales volume and lifetime

Unit production cost

Unit revenue

Discount rate

$1.8million, 18 months

$400K, 1 year

$250k, 6 months

$150k, 6 months

$250k + $80k/year for product life

200k units/year, lifespan 2.5 years= 500k units

$44/unit + $2/unit overhead

$56/unit wholesale

10%/year


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


Go to the Excel Spreadsheet example


Rule of 78The 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?


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 decisionsProduct development time versus product costCustom development, tooling, test fixtures

versus product cost


Personal economics

What ways do companies compensate employees?

Salary Bonuses Stock options.


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 windowOnly after a specific date—usually a

percentage each year.Expiration date—usually 5 years


Stock Options Example

Option to buy 500 shares of XYZ Corp at $24 per share

If XYZ shares are at $30 per shareMake $3000 today (30-24*500)Wait till tomorrow and make $3500 (or $2000)

If XYZ shares fall to $23.75 per shareWorth nothingWait till tomorrow


Stock Options Key Factors

Most options are given out at prices at the current market valueMarket $18 per shareOption price $18 per share

Most option have a waiting period1 to 2 yearsWhen (If) the company goes public

Most options terminate with employment


Stock OptionsEmployment 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?


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)


Homework assignment – dueMar 3rd . 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, the required equipment, and if you are at a stage to actually run the test, also include the test results.

Documents

ECEN 490 1 Winter 2015 Product Development Economics