1 Rev: 5/05/07 MSE-415: B. Hawrylo Chapter 15 Product Development Economics MSE-415: Product Design...

1Rev: 5/05/07 MSE-415: B. Hawrylo

Chapter 15Product Development Economics

MSE-415: Product DesignLecture #14

MSE-415: Product DesignLecture #14


Lecture Objectives:Lecture Objectives:

•Discuss Product Development Economics


Product Development Economics

Product Development Economics

•A product is economically viable if the value in the market is greater than the cost by a designated margin justifies the investment required to produce the product.

•Cash Inflows Revenue from the product sale

•Cash Outflows One-time development cost (engineering) Production cost (labor, equipment, etc.) Marketing On-going production cost (raw material, maintenance, etc.) Support cost


Example: Fingernail Clipper

Example: Fingernail Clipper


Product Development Cash Flow

Product Development Cash Flow

Sales Revenue

Operating Profit

Operating Costs

Break EvenTime

PaybackTime

DevelopmentTime

Time

Net Profit$’s

+

Investment

-


Inputs for Economic Analysis

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

• 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


What is money worth?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

Net Present Value

NPV =period cash flow(1 + discount rate)

period

periods

NPV =C

(1 + r)i

Ni

i = 1


Net Present Value Example

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


Example

Example

X corporation must decide whether to introduce a new product line. The new product will have startup costs, operational costs, and incoming cash flows over six years. This project will have an immediate (t=0) cash outflow of $100,000 (which might include machinery, and employee training costs). Other cash outflows for years 1-6 are expected to be $5,000 per year. Cash inflows are expected to be $30,000 per year for years 1-6. All cash flows are after-tax, and there are no cash flows expected after year 6. The required rate of return is 10%. The present value (PV) can be calculated for each year:


Example (Answer)Example (Answer)

T=0 -$100,000 / 1.100 = -$100,000 PV. T=1 ($30,000 - $5,000) / 1.101 = $22,727 PV. T=2 ($30,000 - $5,000) / 1.102 = $20,661 PV. T=3 ($30,000 - $5,000) / 1.103 = $18,783 PV. T=4 ($30,000 - $5,000) / 1.104 = $17,075 PV. T=5 ($30,000 - $5,000) / 1.105 = $15,523 PV. T=6 ($30,000 - $5,000) / 1.106 = $14,112 PV.

•The sum of all these present values is the net present value, which equals $8,881. Since the NPV is greater than zero, the corporation should invest in the project.


Project Financial Analysis

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

Qualitative Factors

•Project technology has application to other future projects

•Competition•Keep product line current•Comprehensive product line•Social Trends•Support or auxiliary products•Potential breakthrough technology•Government trends•The boss likes it•etc.


What is money worth?What is money worth?

•Bank Interest 5-6%•Corporate Earning Rate 10-12%•Marginal Rate for new projects 10-18%

Why would Marginal rate be higher? Risk of new development Other opportunities for use of funds.


PDA High Capacity Disk Drive

PDA High Capacity Disk Drive

Should we develop a new PDA attachment?


500,000 units at $56/unit = $28,000,000Cost of 500,000 units at $46/unit = $23,000,000Gross 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

Quick calculationQuick calculation


Inputs for New Disk Drive Base CaseInputs for New Disk Drive Base Case

• 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


What to RememberWhat 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


Next WeekPresentationsMay 17, 2007

Next WeekPresentationsMay 17, 2007

• Presentation – 100 Points (30 minutes max) Remember you are promoting your invention to venture

capitalists who have money to invest in your idea. Think about:– How complete is your product development process?– How much money do you need, and why?– What is unique about your invention?– How is your invention better than the competition?– Why should I invest in you invention?

• Cost to manufacture

• Profitability

• Development cost

• Homework – Ex. 2 & 3, p. 325

1 Rev: 5/05/07 MSE-415: B. Hawrylo Chapter 15 Product Development Economics MSE-415: Product Design...

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