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New Car SimulationNew Car SimulationNew Car SimulationNew Car Simulation

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New car simulationBasic problem

To simulate the profitability of a new model car over a several-year period to check its profitability in terms of net present value (NPV)

NPV is used so that company can compare this investment with other potential investments

Many costs are uncertain at the outset

To simulate the profitability of a new model car over a several-year period to check its profitability in terms of net present value (NPV)

NPV is used so that company can compare this investment with other potential investments

Many costs are uncertain at the outset

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New car simulationUncertainties

Yearly demand for car - assumptions are: Demand in year 1 is normally distributed, known mean

and standard deviation Demand in typical year is normally distributed, known

standard deviation, mean equal to actual demand in previous year

Builds in correlation among demands

Yearly demand for car - assumptions are: Demand in year 1 is normally distributed, known mean

and standard deviation Demand in typical year is normally distributed, known

standard deviation, mean equal to actual demand in previous year

Builds in correlation among demands

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New car simulationUncertainties

Fixed development cost (only in year 1) Assumed normally distributed, known mean and

standard deviation

Fixed development cost (only in year 1) Assumed normally distributed, known mean and

standard deviation

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New car simulationUncertainties

Variable unit production cost - assumptions are: Variable cost in year 1 is normally distributed with

known mean, standard deviation Variable cost in a typical year is previous year’s value

times an inflation factor Inflation factor each year is normally distributed with

known mean, standard deviation

Variable unit production cost - assumptions are: Variable cost in year 1 is normally distributed with

known mean, standard deviation Variable cost in a typical year is previous year’s value

times an inflation factor Inflation factor each year is normally distributed with

known mean, standard deviation

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New car simulationRevenues

Unit price is set in year 1 Unit price in a typical year is price from previous year

times the same inflation factor used for variable costs

Unit price is set in year 1 Unit price in a typical year is price from previous year

times the same inflation factor used for variable costs

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New car simulationOther assumptions

Production quantity in any year is set as: Expected (forecast) demand plus a multiple of the

standard deviation of demand This multiple is essentially a decision variable

Leftover cars any year are sold at a 30% discount For purposes of calculating NPV, interest rate of 10%

is used

Production quantity in any year is set as: Expected (forecast) demand plus a multiple of the

standard deviation of demand This multiple is essentially a decision variable

Leftover cars any year are sold at a 30% discount For purposes of calculating NPV, interest rate of 10%

is used

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Developing the spreadsheet model(See Excel “Step 1” sheet)

Step 1: Enter all assumptions and inputs, including: Parameters of various normal distributions Multiple that determines production strategy Percentage markdown for leftover cars Interest rate

Step 1: Enter all assumptions and inputs, including: Parameters of various normal distributions Multiple that determines production strategy Percentage markdown for leftover cars Interest rate

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Developing the spreadsheet model (See Excel “Steps 2-8” sheet)

Steps 2-8: Calculate the following, generating random numbers when needed: Inflation factors Production quantities Demands Variable costs Revenues

Steps 2-8: Calculate the following, generating random numbers when needed: Inflation factors Production quantities Demands Variable costs Revenues

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Developing the spreadsheet model (See Excel “Steps 9-11” sheet)

Step 9: Generate the (one-time) fixed cost Step 10: Use Excel’s NPV function to calculate the

NPV of the production cost stream and the revenue stream

Step 11: Calculate the total NPV The fixed cost is tacked on separately because it occurs

right away and isn’t discounted

Step 9: Generate the (one-time) fixed cost Step 10: Use Excel’s NPV function to calculate the

NPV of the production cost stream and the revenue stream

Step 11: Calculate the total NPV The fixed cost is tacked on separately because it occurs

right away and isn’t discounted

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Developing the spreadsheet model (See Excel “Replications” sheet)

Create a data table to replicate the simulation Keep track of total NPV for the 10-year period

Calculate summary measures (average, standard deviation, minimum, maximum, frequency table, confidence interval for mean NPV) based on this data table

Create a data table to replicate the simulation Keep track of total NPV for the 10-year period

Calculate summary measures (average, standard deviation, minimum, maximum, frequency table, confidence interval for mean NPV) based on this data table

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Developing the spreadsheet model (See Excel “Histogram” sheet)

Based on the frequency table, create a histogram of the total NPVs

The three left-most bars are of particular importance to the company They show how often a negative NPV is obtained

Based on the frequency table, create a histogram of the total NPVs

The three left-most bars are of particular importance to the company They show how often a negative NPV is obtained