ECEN Winter 2015 Product Development Economics

ECEN Winter 2015 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 = $ But you will actually pay 59 payments of $188.71, and 1 payment of $ This is a total of $11, Why a different final payment?

ECEN Winter 2015 Project - Economic Evaluations Planning Concept Development Concept Development System-Level Design System-Level Design Detail Design Detail Design Testing and Refinement Testing and Refinement Production Ramp-Up Production Ramp-Up Go/No-Go Decision Gates Sensitivity and Trade-off Analysis

ECEN Winter 2015 Product Development Cash Flow Sales Revenue Operating Profit Operating Costs Break Even Time Payback Time Development Time Time Net Profit $’s + Investment -

ECEN Winter 2015 Inputs for Economic Analysis Initial Expenses  Development cost and timing  Testing cost and timing  Tooling investment and timing  Ramp-up cost and timing  Marketing and support cost and timing

ECEN Winter 2015 Inputs for Economic Analysis Ongoing Expenses  Marketing cost and timing  Product support cost and timing  Unit production cost  Displaced product revenue Ongoing Income  Unit revenue  Sales volume and lifetime Discount rate  Cost of acquiring money in the company

ECEN Winter 2015 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

ECEN Winter 2015 Net Present Value NPV = period cash flow (1 + discount rate) period periods  NPV = C (1 + r) i  N i i = 1

ECEN Winter 2015 Net Present Value Example NPV = C (1 + r) i  N i i = Dollars per year for the next 5 years 6% interest (discount rate) NPV = 100/(1.06) + 100/(1.06) /(1.06) /(1.06) /(1.06) 5 NPV = 100/ / / / /1.34 NPV = $421.24

ECEN Winter 2015 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.

ECEN Winter 2015 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.

ECEN Winter 2015 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 development  Other opportunities for use of funds.

ECEN Winter 2015 PDA High Capacity Disk Drive Should we develop a new PDA attachment?

ECEN Winter 2015 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

ECEN Winter 2015 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

ECEN Winter 2015 Go to the Excel Spreadsheet example

ECEN Winter 2015 Rule of 78 The 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?

ECEN Winter 2015 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 decisions  Product development time versus product cost  Custom development, tooling, test fixtures versus product cost

ECEN Winter 2015 Personal economics What ways do companies compensate employees? Salary Bonuses Stock options.

ECEN Winter 2015 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 window  Only after a specific date—usually a percentage each year.  Expiration date—usually 5 years

ECEN Winter 2015 Stock Options Example Option to buy 500 shares of XYZ Corp at $24 per share If XYZ shares are at $30 per share  Make $3000 today (30-24*500)  Wait till tomorrow and make $3500 (or $2000) If XYZ shares fall to $23.75 per share  Worth nothing  Wait till tomorrow

ECEN Winter 2015 Stock Options Key Factors Most options are given out at prices at the current market value  Market $18 per share  Option price $18 per share Most option have a waiting period  1 to 2 years  When (If) the company goes public Most options terminate with employment

ECEN Winter 2015 Stock Options Employment 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?

ECEN Winter 2015 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)

ECEN Winter 2015 Homework assignment – due Mar 3rd. Design a test procedure that you will use to validate one of the key project specifications that you identified in your FSD. 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.