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Chapter 15: Product Development Economics

Chapter 15: Product Development Economics. Product Design and Development Fourth Edition by Karl T. Ulrich and Steven D. Eppinger. Adapted from Dr. Stamper. General Equations for Compound Interest. Future Value: Present Value: Where: F is future value P is present value

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Chapter 15: Product Development Economics

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  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

  7. Step 1: Build a Base-Case Model

  8. Step 1: Build a Base-Case Model

  9. 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

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

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

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

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

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

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

  16. 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”

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

  18. 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

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

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