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Chapter 15: Product Development Economics

Learn economic metrics, NPV comparison, depreciation methods, ROI, IRR, qualitative factors, and uncertainty modeling in project evaluation. Understand how to conduct sensitivity analysis and make informed project decisions.

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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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