Market Analysis and Models of Investment. Product Development and Whole Life Cycle Costing

Transcription

1 The Universiy of Liverpool School of Archiecure and Building Engineering WINDS PROJECT COURSE SYNTHESIS SECTION 3 UNIT 11 Marke Analysis and Models of Invesmen. Produc Developmen and Whole Life Cycle Cosing Inroducion The compeiive naure of he consrucion indusry requires ha manufacurers mus now seek o no only coninually increase he qualiy of work ha is produced, bu also seek o gain an economic compeiive advanage in he marke place. The long erm cos performance of componens and projecs is now an imporan heme in he indusry, where before, he iniial capial coss where he predomenanly he key decision variable in deciding beween compeing alernaives. This uni will look a how manufacurers can use economic principles o aid he developmen of componens and how effecive marke analysis forms par of his. The uni will hen look a more deail ino whole life cosing and he issues associaed wih his. The benefis of using a whole life cos approach in erms of invesmen planning and decision making will also be addressed. 1. The imporance of economic principles in produc developmen Marke Invesigaion Invesigaion of he marke condiions for a produc or service is a necessary precursor o developmen of a business plan. The characerisics of he produc iself are imporan bu so oo is he environmen ino which i will be sold. Par of he difficuly here is ha no only mus he curren siuaion be examined, bu so oo mus hisorical condiions, in order o make predicions abou he fuure. Anyhing, which may play a par in he business feasibiliy of he produc and indeed of he whole organisaion, needs o be assessed. For some indusries, his implies very long erm forecasing exending perhaps o weny years or longer. Quie ofen i is he exended period which is mos significan in profiabiliy erms, raher han he shor-erm selling price and apparen margins. This concep form he fundamenals of whole life cycle cosing, ha is, he sysemaic consideraion of long erms coss, no jus he shor erms ones. A key issue when considering he inroducion of a new produc is he abiliy of he organisaion o develop and suppor i. This is rue wheher he produc is a physical one or a service. For boh ypes of produc, he skills, knowledge and echnology mus be available in adequae quaniies in he righ place. Two ways of considering his requiremen are capabiliy and capaciy. The former is concerned wih a fundamenal abiliy o perform whaever ask is required. I may be ha he organisaion srucure, or business procedures acually preven cerain asks from being compleed (e.g. Universiy Regulaions). The laer is concerned wih he abiliy o absorb he ask ino

2 he ongoing operaions of he business. New producs almos always pose problems in boh regards. I is herefore mos imporan o idenify he problems before pressing on wih a produc developmen, which may urn ou o be inappropriae for he business. The oal business plan The managemen eam should share he ask of preparing he business plan, alhough i is normally pruden o use exernal consulans and independen financial advisers as par of his process. The business plan for he produc developmen process should include: A fully cosed produc and markeing plan This is an inegral par of he overall economic sraegy of he projec and should ake ino accoun he produc lifecycle and evaluaion A fully cosed resource plan The resource plan should look a saffing, incremenal overhead coss and capial requiremens of he developmen process A lis of imporan, clearly defined managemen acions (raher han general exhoraions) The exisence of a clear and srucured managemen hiearchy (as discussed in earlier unis) i essenial o mainain, accounabiliy, qualiy and efficiency in he developmen process. The way in which he managemen communicaes wih subordinaes is an imporan issue here as well. Financial projecions and risk assessmens for each quanifiable aciviy wihin he developmen process The esablishmen or rigorous audi procedures should be in place o ensure bes value hroughou he produc developmen sages. Each sage mus also incorporae sochasic echniques o idenify he risk in invesmen and financial oulay and produc manufacuring sages. The financial evaluaion of produc developmen There are many ways in which he financial evaluaion of he produc developmen sage can be assessed. These echniques, which are commonly used in whole life cycle cosing mehodologies, are vial o ensure ha he financial viabiliy, risks and coningencies have been aken fully ino accoun. Wha ever echniques is used in his process, i mus: Be logical in relaion o inflaion, discouning and ineres rae assumpions, as hese facors srongly inerrelae Be clear and consisen wih regard o depreciaion, ineres and axaion Produce clear resuls which are simple o inerpre and disseminae o sakeholders These financial evaluaions hough mus include no jus be viewed as sand alone opions, hey mus also include he opporuniy cos ha is he cos of doing nohing.

3 The calculaions should reflec he incremenal differences compared wih aking no acion, for if he produc developmen invesmen is delayed for o long, he whole projec may be jepordised. All financial aspecs of a projec mus be aken ino accoun in he financial evaluaion. Techniques for financial evaluaion The mos commonly used echniques ha are used in financial evaluaion are: The Payback Period (PP) mehod The Average Reurn on Invesmen (ARI) mehod The Discouned Cash Flow (DCF) mehod, incorporaing he Ne Presen Value Mehod and he Inernal Rae of Reurn (IRR) Mehod The Payback Period Mehod Payback period is he ime from he sar of he produc developmen process o he ime when all invesmen expendiure on he process has been recouped. The payback mehod is favoured because of is ease of calculaion bu i has many significan failings, especially in longer-erm developmen process where he ime value of money is a significan facor. Generally, his ool is used as ranking mehod for alernaive projecs of similar characerisics. The general formula for calculaing payback is given by: ( S y = 1 (1 + d) I ) I 0 Where: y = minimum lengh of ime over which fuure ne cash flows have o be accumulaed in order o offse iniial capial cos invesmen S = Savings in operaional coss in year associaed wih an alernaive projec = Iniial invesmen coss associaed wih he alernaive I 0 I = Addiional invesmen relaed coss in year, oher han invesmen coss d = discoun rae Sricly speaking, he weighed average dae of he projec cash ouflow and invesmen should be used as he sar of he payback period. If exra money is being borrowed o finance he projec, he ineres cos of his money should also be aken ino accoun. The limiaions of he payback period echnique are: 1) is insensiive o cash flow wihin pariclular ime periods 2) ignores he ime value of money 3) akes no accoun of cash flows afer payback has been achieved

4 4) requires specific crieria for accepabiliy o be esablished for he paricualr business, eiher by reference o compeiion or arbirarly Average reurn on invesmen The general convenion on calculaing reurn on invesmen is before ineres and ax. Inflaion and capial consumpion charges should be aken ino accoun when using his mehod, bu as wih all evaluaions mehods, conservaive assumpions should be used, especially when only one se of figures is being produced and here is no accompnaying risk analysis. This mehod comprises of hree specific elemens 1. Esimaed fuure inflaion. This is he noional ineres required o mainain - afer ax - he capial value of moneary invesmen in real, purchasing power erms 2. True non-risk ineres. This varies in long-erm cycles depending on general invesmen demand and general savings supply. A good marker is he compound annual reurn over five years obainable on he naional savings index linked cerificaes 3. The risk premium. This is ypically around 5 o 10% bu depends upon he paricular produc developmen process When he inflaion elemen is high and when projecs have o be fiannced o a significan degree by borrowed money, i can become very difficul o provide financial jusificaion for long erm projecs. Cas flow is drained a a criical ime o provide he inflaion-compensaing elemen of ineres. Logic dicaes ha inflaionary price increases should be buil ino projec profi forecass, albei a realisic levels allowing for he decline in a producs compeiiveness over ime. Discouned Cash Flow Techniques 1.1 Inernal Rae of Reurn The inernal rae of reurn measuremen (IRR) is dispued by many as simply a heoreical arihmeic resul as opposed o an economic measure of performance. (see AIRR) The IRR of a projec can be defined as he rae of discoun which, when applied o he projecs cash flows, produces a zero NPV, so in general erms, he IRR is he value for r which saisfies he expression:

5 N = 0 A (1 + d) = 0 The decision rule for IRR is ha only projecs ha have an IRR greaer han or equal o a predefined cu-off poin should be acceped. This cu off rae is usually he marke rae of ineres (i.e. he discoun rae ha would have been used if and NPV analysis were underaken insead). All over invesmen projec opporuniies should be rejeced. The logical behind IRR is similar o ha of NPV. The marke ineres rae reflecs he opporuniy cos of he capial involved. Thus, o be accepable, a projec mus generae a reurn a leas equal o he reurn available elsewhere on he capial marke. 1.2 Adjused Inernal Rae of Reurn (AIRR) The Adjused Inernal Rae of Reurn (AIRR) is a measure of he annual percenage yield from a projec invesmen over he service life of he building (or sudy period in basic erms). Like he NS and SIR measures, i is a relaive calculaion ha needs a base case for comparison. AIRR is used o compare agains he minimum accepable rae of reurn (MARR) Minimum Accepable Rae of Reurn (on capial). The smalles amoun of revenue considered accepable for an organisaion o underake a projec. Typically, MARR is equal o he cos of capial plus a reurn. Someimes referred o as he hurdle rae.

6 This is generally equal o he discoun rae used in he LCC analysis. If he AIRR is greaer han he MARR, hen he projec can be defined as economic, if less i is deemed unworhy of invesmen. If AIRR is equal o he discoun rae, his is breakeven and hence economically neural. AIRR can be used in he same fashion as SIR. The AIRR, in conras o he IRR measure, explicily assumes ha he savings generaed by he projec can be reinvesed a he discoun rae for he remainder of he service life. (if hese savings could be reinvesed a a higher rae han he discoun rae, hen he discoun rae would no represen he opporuniy cos of capial. IRR implicily assumes ha inerim savings can be reinvesed a he calculaed rae of reurn on he projec, an assumpion ha leads o over-esimaion of he projecs yield if he calculaed rae of reurn is higher han he reinvesmen rae. AIR and IRR are only he same if he invesmen yields a single, lump sum paymen a he end of he service life, or in he unlikely case when he reinvesmen rae is he same as he IRR. As discussed earlier, some dispue IRR as a performance measure in ha more han one rae of reurn may make he value of he savings and invesmen sreams be equal, as required by he definiion of he inernal rae of reurn. This may be he case when capial invesmen coss are incurred during laer years, giving rise o negaive cash flows in some years. The formulae for calculaing AIRR is given by (find i for which saisfies: N = o S (1 + r) (1 + i) N N N = 0 I (1 = r) = 0

7 where: S = Annual savings generaed by he projec, reinvesed a he reinvesmen rae r = Rae a which available savings can be reinvesed, usually equal o he MARR (i.e. he discoun rae) I ( 1+ r) = Presen value invesmen coss on which reurn is o be maximised