Exam 11: Simulation Models

Exhibit 11-1A company is considering investing $1.2M in a facility to manufacture a new product. The product will have a five year life, after which the facility will be shut down. A pro forma cash flow sheet for this project, with forecasted production levels, unit prices, and production costs, is shown below: -[Part 3] Refer to Exhibit 11-1. What is the standard deviation of the NPV? What does it indicate?

The main issue in marketing and sales models is:

Exhibit 11-2Suppose we want to choose capacity for a plant that will produce a new drug. In particular, we want to choose the capacity that maximizes discounted expected profit over the next 10 years. Assume all cash flows occur at the end of the year. We have the following information: ∙Demand for the drug is expected to be normally distributed ˜ Normal (50,000, 12,000). Demand each year is an independent event. ∙A unit of capacity costs $16 to build in year 1. ∙The number of units produced will equal the demand, up to capacity limits. ∙The revenue per unit is $3.70 and the cost per unit is $0.20 (variable cost). ∙The maintenance cost per unit of capacity is $0.40 (fixed cost). ∙The discount rate is 10%. -[Part 2] Refer to Exhibit 11-2. Use a RISKSIMTABLE to with the following values for capacity: 20,000, 25,000, 30,000, 35,000, 40,000. Which of these capacities produces the largest expected NPV?

A tornado chart lets us see which random input has the most effect on a specified output in a financial model.

Exhibit 11-2Suppose we want to choose capacity for a plant that will produce a new drug. In particular, we want to choose the capacity that maximizes discounted expected profit over the next 10 years. Assume all cash flows occur at the end of the year. We have the following information: ∙Demand for the drug is expected to be normally distributed ˜ Normal (50,000, 12,000). Demand each year is an independent event. ∙A unit of capacity costs $16 to build in year 1. ∙The number of units produced will equal the demand, up to capacity limits. ∙The revenue per unit is $3.70 and the cost per unit is $0.20 (variable cost). ∙The maintenance cost per unit of capacity is $0.40 (fixed cost). ∙The discount rate is 10%. -[Part 3] Refer to Exhibit 11-2. Briefly explain why designing the plant for the expected capacity is clearly not the optimal solution.

The value at risk (VAR) is typically defined as the:

Suppose we compare the difference between the NPV of a financial model in which the means are entered for all input random variables and the NPV of a financial model in which the most likely values are entered for all input random variables. If we see a large difference between the NPV's, this illustrates:

A marketing simulation model can be used to determine the expected profit under uncertain customer loyalty, but an optimization model must be used to determine the optimal amount to spend on increasing customer loyalty.

Exhibit 11-1A company is considering investing $1.2M in a facility to manufacture a new product. The product will have a five year life, after which the facility will be shut down. A pro forma cash flow sheet for this project, with forecasted production levels, unit prices, and production costs, is shown below: -[Part 5] Refer to Exhibit 11-1. What are the chances the firm could lose money on this project, given the price uncertainty?

Exhibit 11-1A company is considering investing $1.2M in a facility to manufacture a new product. The product will have a five year life, after which the facility will be shut down. A pro forma cash flow sheet for this project, with forecasted production levels, unit prices, and production costs, is shown below: -[Part 6] Refer to Exhibit 11-1. Given your answers to Parts 1 through 5, would you invest in this project?

In cash flow models, we are typically interested in investigating:

A @RISK output range allows us to obtain a summary chart that shows the entire simulated range at once.

Exhibit 11-1A company is considering investing $1.2M in a facility to manufacture a new product. The product will have a five year life, after which the facility will be shut down. A pro forma cash flow sheet for this project, with forecasted production levels, unit prices, and production costs, is shown below: -[Part 2] Refer to Exhibit 11-1. Suppose that the forecasted price levels shown in the pro forma cash flow sheet are not deterministic, but rather are expected to fluctuate due to market forces. The prices are expected to be normally distributed in each year, with the following means and standard deviations:Using the appropriate @RISK functions in the pro forma, what is the expected NPV? Would you recommend investing in this project? Explain. Year 1 2 3 4 5 Mean \ 27.40 \ 26.60 \ 25.50 \ 24.80 \ 23.50 Std. Dev. \ 5.50 \ 5.30 \ 5.00 \ 4.50 \ 4.10

Exhibit 11-1A company is considering investing $1.2M in a facility to manufacture a new product. The product will have a five year life, after which the facility will be shut down. A pro forma cash flow sheet for this project, with forecasted production levels, unit prices, and production costs, is shown below: -[Part 1] Refer to Exhibit 11-1. What is the deterministic next present value (NPV) of the project, including the required investment, assuming a 10% discount rate?

Which of the following is the most likely characteristic of a distribution that is to be used to develop a simulation model for estimating the time until failure of a product in a simulation model?

The RISKSIMTABLE function is used to summarize the results of a single simulation of product lifetime.

A common distribution for modeling product lifetimes is the normal distribution

Exhibit 11-2Suppose we want to choose capacity for a plant that will produce a new drug. In particular, we want to choose the capacity that maximizes discounted expected profit over the next 10 years. Assume all cash flows occur at the end of the year. We have the following information: ∙Demand for the drug is expected to be normally distributed ˜ Normal (50,000, 12,000). Demand each year is an independent event. ∙A unit of capacity costs $16 to build in year 1. ∙The number of units produced will equal the demand, up to capacity limits. ∙The revenue per unit is $3.70 and the cost per unit is $0.20 (variable cost). ∙The maintenance cost per unit of capacity is $0.40 (fixed cost). ∙The discount rate is 10%. -[Part 1] Refer to Exhibit 11-2. Perform a simulation assuming the plant will be designed to meet the expected demand. What is the net present value (NPV) in that case?

A key input variable in many marketing models of customer loyalty is the:

In warranty cost models, the key input random variable is product lifetime.