Chapter 15: Product

Development
Economics
Product Design and Development
Fourth Edition
by Karl T. Ulrich and Steven D. Eppinger

Adapted from Dr. Stamper

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

Net Present Value

Comparison

NPV Costmachine A = $28,823

NPV Costmachine B = $32,793
Costmachine A unadjusted = $29,500
Costmachine B unadjusted = $38,500

Determining the
Distribution
Straight line depreciation
Declining balance depreciation
Sumofyears-digits depreciation

Economic Metrics
to Evaluate Projects
Return on Investment (ROI)
Payback period
Internal Rate of Return

IRR spreadsheet example

Economic Analysis
for Product Development
(Ulrich and Eppinger)

1.
2.
3.

4.

5.

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

Step 1: Build a Base-Case Model

Step 1: Build a Base-Case

Model

Using Excel for Q4 of Year 1:

Present Value of Year 3 Costs:
(-2250)/(1+0.10/4)^3= -$2089

Annual interest
divided by number
of periods per year

Future Value

Payments Made Each Period

Number of periods

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 Tradeoff Rules from sensitivity analyses)

Ulrich & Eppinger, Product Design and Development

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

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
Ulrich & Eppinger, Product Design and Development

Step 5: Consider Uncertainty

Modeling Uncertain
Cash Flows
Dealing With Risk

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

NPV with market testing is $2,650,000