Product Design and Development Fourth Edition by Karl T. Ulrich and Steven D. Eppinger Adapted from Dr. Stamper

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

NPV Cost machine A = $28,823 NPV Cost machine B = $32,793 Cost machine A unadjusted = $29,500 Cost machine B unadjusted = $38,500

 Straight line depreciation  Declining balance depreciation  Sum–of–years-digits depreciation

 Return on Investment (ROI)  Payback period  Internal Rate of Return IRR spreadsheet example

1. Build a base-case financial model 2. Perform a sensitivity analysis 3. Use sensitivity analysis to understand project trade-offs 4. Consider the influence of qualitative factors on project success 5. Consider Uncertainty

Step 1: Build a Base-Case Model

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

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

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

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

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

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

What are some situations when you might not pursue an option that presents the best NPV?

Step 4: Consider the Influence of Qualitative Factors Ulrich & Eppinger, “Product Design and Development” 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)

Dealing With Risk Step 5: Consider Uncertainty

Probability that the Patent is allowed NPV= P a *PV a + P b *PV b = 0.6($6.5 million) + 0.4($1.5 million) = $4.5 million Determining NPV with probabilities.

NPV with market testing is $2,650,000

Find the NPV for a Pharmaceutical project: – Years 1-5 development: $3M/year – Years 5-9 FDA testing, IP costs, manufacturing ramp up: $ 5M/year – Year 10 until expiration of patent Volume: 57M units / year Revenue: $0.35 / unit Costs: $0.12 / unit – Patent issues at start of year 9 and is enforceable for 17 years – Cost of money is 8% What happens if the FDA testing takes twice as long as planned (still at $5M/year)