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Published byEmma O’Neal’ Modified over 4 years ago

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Spreadsheet Demonstration New Car Simulation

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2 New car simulation Basic problem To simulate the profitability of a new model car over a several-year period to check its profitability in terms of net present value (NPV) NPV is used so that company can compare this investment with other potential investments Many costs are uncertain at the outset To simulate the profitability of a new model car over a several-year period to check its profitability in terms of net present value (NPV) NPV is used so that company can compare this investment with other potential investments Many costs are uncertain at the outset

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3 New car simulation Uncertainties Yearly demand for car - assumptions are: Demand in year 1 is normally distributed, known mean and standard deviation Demand in typical year is normally distributed, known standard deviation, mean equal to actual demand in previous year Builds in correlation among demands Yearly demand for car - assumptions are: Demand in year 1 is normally distributed, known mean and standard deviation Demand in typical year is normally distributed, known standard deviation, mean equal to actual demand in previous year Builds in correlation among demands

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4 New car simulation Uncertainties Fixed development cost (only in year 1) Assumed normally distributed, known mean and standard deviation Fixed development cost (only in year 1) Assumed normally distributed, known mean and standard deviation

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5 New car simulation Uncertainties Variable unit production cost - assumptions are: Variable cost in year 1 is normally distributed with known mean, standard deviation Variable cost in a typical year is previous year’s value times an inflation factor Inflation factor each year is normally distributed with known mean, standard deviation Variable unit production cost - assumptions are: Variable cost in year 1 is normally distributed with known mean, standard deviation Variable cost in a typical year is previous year’s value times an inflation factor Inflation factor each year is normally distributed with known mean, standard deviation

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6 New car simulation Revenues Unit price is set in year 1 Unit price in a typical year is price from previous year times the same inflation factor used for variable costs Unit price is set in year 1 Unit price in a typical year is price from previous year times the same inflation factor used for variable costs

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7 New car simulation Other assumptions Production quantity in any year is set as: Expected (forecast) demand plus a multiple of the standard deviation of demand This multiple is essentially a decision variable Leftover cars any year are sold at a 30% discount For purposes of calculating NPV, interest rate of 10% is used Production quantity in any year is set as: Expected (forecast) demand plus a multiple of the standard deviation of demand This multiple is essentially a decision variable Leftover cars any year are sold at a 30% discount For purposes of calculating NPV, interest rate of 10% is used

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8 Developing the spreadsheet model (See Excel “Step 1” sheet) Step 1: Enter all assumptions and inputs, including: Parameters of various normal distributions Multiple that determines production strategy Percentage markdown for leftover cars Interest rate Step 1: Enter all assumptions and inputs, including: Parameters of various normal distributions Multiple that determines production strategy Percentage markdown for leftover cars Interest rate

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9 Developing the spreadsheet model (See Excel “Steps 2-8” sheet) Steps 2-8: Calculate the following, generating random numbers when needed: Inflation factors Production quantities Demands Variable costs Revenues Steps 2-8: Calculate the following, generating random numbers when needed: Inflation factors Production quantities Demands Variable costs Revenues

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10 Developing the spreadsheet model (See Excel “Steps 9-11” sheet) Step 9: Generate the (one-time) fixed cost Step 10: Use Excel’s NPV function to calculate the NPV of the production cost stream and the revenue stream Step 11: Calculate the total NPV The fixed cost is tacked on separately because it occurs right away and isn’t discounted Step 9: Generate the (one-time) fixed cost Step 10: Use Excel’s NPV function to calculate the NPV of the production cost stream and the revenue stream Step 11: Calculate the total NPV The fixed cost is tacked on separately because it occurs right away and isn’t discounted

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11 Developing the spreadsheet model (See Excel “Replications” sheet) Create a data table to replicate the simulation Keep track of total NPV for the 10-year period Calculate summary measures (average, standard deviation, minimum, maximum, frequency table, confidence interval for mean NPV) based on this data table Create a data table to replicate the simulation Keep track of total NPV for the 10-year period Calculate summary measures (average, standard deviation, minimum, maximum, frequency table, confidence interval for mean NPV) based on this data table

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12 Developing the spreadsheet model (See Excel “Histogram” sheet) Based on the frequency table, create a histogram of the total NPVs The three left-most bars are of particular importance to the company They show how often a negative NPV is obtained Based on the frequency table, create a histogram of the total NPVs The three left-most bars are of particular importance to the company They show how often a negative NPV is obtained

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