Decision & Risk Analysis for Product Introduction€¦ · Decision & Risk Analysis for Product...
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Decision & Risk Analysis for Product Introduction GoldSim Users Conference October 11 – 13, 2004
Transcript of Decision & Risk Analysis for Product Introduction€¦ · Decision & Risk Analysis for Product...
Decision & Risk Analysis for Product Introduction
GoldSim Users ConferenceOctober 11 – 13, 2004
The Book of Risk
Fortunately, the basic ideas of risk management are really very simple: Risk means being exposed to the possibility of a bad outcome. Risk management means taking deliberate action to shift the odds in your favor—increasing the odds of good outcomes and reducing the odds of bad outcomes.
The Book of Risk, Borge, Dan, New York John Wiley & Sons, Inc. (US), 2001. ISBN: 0471323780 eBook ISBN: 0471196703
Spreadsheet -- Volume
Volume
Sales Price $ / Unit
Total Sales $
Cost $ / Unit
Total Costs $
Gross Profit $
Summary $
Revenue
Inflated Revenue
Operating ExpenseCost of Goods Sold
Profit After Tax
Internal Rate of Return
Inflated Expenses
Net Present Value
Cash Flow Adjustments
Spreadsheet – Cash Flow
Traditional Spreadsheet Model
Static model delivers one number.
One number is subject to bias.
The choice of the best case income and the choice of the best case expense will result in overstated income.
Managers need to know the cumulative risks associated with varying degrees of Income and Expense.
Table 1 Inputs -- Spreadsheet
Table I High Level Uncertain Inputs Item No.
Description Physical Units
Value Comments
1 Sales M$/year ~ 13 7 year duration, start 2006 2 Avoided Lost
Margins M$/year ~ 21 7 year duration, start 2006
3 Machinery & Equipment
M$/year ~ 3 3 year duration, start 2003
4 Cost of Sales M$/year ~ 10 7 year duration, start 2006 5 R&D M$/year ~ 6 4 year duration, start 2003 6 Other M$/year ~ 1.6 2 year duration, start 2005 7 8 9
Table 1 Inputs -- GoldSim
Table I High Level Uncertain Inputs Item No.
Description Physical Units
Value Comments
1 Sales M$/year ~13 (5, 11,15) 7 year duration, start 2006 2 Avoided Lost
Margins M$/year ~21 (21, 21, 21) 7 year duration, start 2006
3 Machinery & Equipment
M$/year ~ 3 (2.9, 3.3, 4)
3 year duration, start 2003
4 Cost of Sales M$/year ~ 10 (5, 8, 12) 7 year duration, start 2006 5 R&D M$/year ~ 7 (7, 8, 9) 4 year duration, start 2003 6 Other M$/year ~ 1.6 (1.6, 3, 5,) 2 year duration, start 2005
Model
25 30 35 40 45 50 55
NPV (Millions)
Sales_MN [$]
Reduce_COS_MN [$]
ALM_MN [$]
Exp_Calc_MX [$]
RnD_MN [$]
Sensitivity Table 1From GS: Expected NPV = $42.3M, ΗΗΗΗ = $5.4M , CV = 5.4 / 42.3 = 0.127
Deterministic Model Expceted NPV = $43.5
Sales carries the most variability, and thus more risk. The next
step would be to analyze Sales to see where this variability is
introduced and how to manage
it.
Table 2 Inputs -- SpreadsheetTable II Intermediate Level Uncertain Inputs
Item No.
Description Physical Units
Value Comments: Need 3 point 10, 50, 90 curve
1 Product 1 Volume
Units/year ~ 300
2 Product 1 ∆ Price
$/unit ~ 7500
3 Product 2 Volume
Units/year ~ 1150
4 Product 2 ∆ Price
$/unit ~ 7500
5 Product 3 Volume
Units/year ~ 120
6 Product 3 ∆ Price
$/unit ~ 8000
7 Product 4 Volume
Units/year ~ 140
8 Product 4 ∆ Price
$/unit ~ 8000
9 Product 5 ∆ Volume
Units/year ~ 50
10 Product 5 ∆ Price
$/unit ~ 9000
Table 2 Inputs -- GoldSim
Table II Intermediate Level Uncertain Inputs
Item No.
Description Physical Units
Value Comments: Need 3 point 10, 50, 90 curve
1 12H Volume Units/year ~ 300 (270, 275, 300) 2 12H ∆ Price $/unit ~ 7500 (3500, 5500, 7500) 3 140 H Volume Units/year ~ 1150 (950, 1000, 1150) 4 140H ∆ Price $/unit ~ 7500 (3500, 5500, 7500) 5 143H Volume Units/year ~ 120 (100, 120, 130) 6 143H ∆ Price $/unit ~ 8000 (4000, 6000, 8500) 7 160H Volume Units/year ~ 140 (125, 130, 140) 8 160H ∆ Price $/unit ~ 8000 (4000, 6000, 8000) 9 163H Volume Units/year ~ 50 (40, 50, 55) 10 163H ∆ Price $/unit ~ 9000 (4500, 6500, 9500)
Model
25 27 29 31 33 35 37 39 41 43 45
NPV (Millions)
Car Price
Car Volume
Truck Price
Trailers Price
Motorcycle Price
Wagon Volume
Trailers Volume
Truck Volume
Wagon Price
Motorcycle Volume
Net Sales Sensitivity, Table 2From GS:Expected NPV = $38.3M, σσσσ = $3.9M , CV =3.9 / 38.3 = 0.101
Deterministic Model Expceted NPV = $33.5M
In this case, the car price and volume have the largest variability.
By identifying this risk, management can now take steps to mitigate
these risks for a profitable outcome.
Model -- Analysis
•If management had used the deterministic approach, they would have had only a 5% chance of producing this revenue level or higher.
Questions
Contact: Karen E. Curry, CPASenior Business Analyst
CGN & Associates415 SW WashingtonPeoria, IL 61602
Email: [email protected]: 309-495-2505FAX: 309-495-2308
Root -- Model Screenshot
For your reference:
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Simulation -- Model Screenshot
For your reference:
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Global Container -- Screenshot
For your reference:
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Model Screenshot
For your reference:
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Year benefit begins.
Year benefit ends. Note that either could be stochastic
Model
For your reference:
Slide not presented at ConferenceOne way to load Min/Mode/Max
discounted, and inflated values
Per Andrew’s presentation.
Undiscounted and Un-inflated values
Model
For your reference:
Slide not presented at ConferenceAnother way to load Min/Mode/Max (MMM). This would be a way to load a different MMM for each time period
Sensitivity—Tornado Inputs
For your reference:
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To get inputs for Tornado Diagram, the model is run deterministically with the ‘mode’ values. (The tool tip is highlighted in the picture)
The other variables are changed to their minimums and maximums one at a time.
The resulting values are captured in the time history and exported to Excel for charting. It looks like this may be easier in v8.10…Yeah!
Sensitivity—Tornado Inputs
For your reference:
Slide not presented at Conference
25 30 35 40 45 50 55
NPV (Millions)
Sales_MN [$]
Reduce_COS_MN [$]
ALM_MN [$]
Exp_Calc_MX [$]
RnD_MN [$]
Sensitivity Table 1From GS: Expected NPV = $42.3M, ΗΗΗΗ = $5.4M , CV = 5.4 / 42.3 = 0.127
Deterministic Model Expceted NPV = $43.5 This tornado diagram shows that sales provide the most variation. The next logical step would be to break sales down into its components to identify where the most variability comes from. (slide #11) Management can then take steps to manage the risk associated with the production of this product. In this case, the client found that the order of product /model introduction reduced this risk to an acceptable levels.
Accounting 101—Profit After TaxADD
Volume * Unit Price of Product = Extended SalesInflate Extended Sales
SUBTRACTVolume * Unit Cost of Product = Extended CostsInflate Extended Costs
Capitalize InterestDepreciation Cost
NETProfit Before Taxes
SUBTRACTIncome Taxes
Profit After Taxes
For your reference:
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Accounting 101—Cash Flow
Profit After Taxes
ADDNon-Cash Expenses (such as Depreciation)
SUBTRACTCash Paid (such as Capital Purchases)
Total After Tax Cash Flow
For your reference:
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Accounting 101--Discounting
Dollar today is worth more than a dollar tomorrow.Net Present Value represents the value of future cash flows in today’s dollar.The higher the NPV, the more desirable the project. Internal Rate of Return is the rate at which future cash flows discount back to zero.
For your reference:
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Abstract
GoldSim Users ConferenceOctober 11—14Title: Decision & Risk Analysis for Product IntroductionAbstract: One of the things a company will do when they want to introduce a new product into the market place is a business case analysis. Using decision and risk analysis will help them to determine where their risks and potential for revenue growth lie. In this case, risk is associated with the variation of revenues and the expenses to generate those revenues.This case demonstrates a two-step process to determine the biggest causes of variation in thepredicted net present value. The first step will permit us to rank the inputs whose uncertainty creates the biggest variation in the net present value of the project. By using, Probabilistic Inputs (uncertain inputs defined by cumulative probability distributions), inputs become cumulative probability distributions by creating values for each input that corresponds to the Minimum, Most Likely and Maximum points on the cumulative probability curve.In step two we will focus on the variation in product volumes (units sold/year) and changes in the product prices ($/unit). For each product, we will represent the variation in volume and price by a cumulative distribution as described in the first step.GoldSim is used to simulate the cumulative probability distribution and will help produce the two tornado diagrams (sensitivity charts). These diagrams will rank the uncertain inputs to determine which inputs create the biggest variation in the net present value. It will allow management to focus on these key project components to help reduce variations and maximize profits.
For your reference:
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Hurdle Rate
Hurdle Rate: This represents the required rate of return needed for a discounted cash flow calculation in the Cash Flow Analysis tab. Typically the hurdle rate is based on the firm’s cost of capital, plus or minus a certain risk premium that reflects the projects specific risk characteristics.
For your reference:
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