As part of the company’s continues commitment to product innovation, the Executive Committee of PLE is debating whether to replace its original tractor model, the PLE-Classic, with a new model, the PLE-Tough, which would appeal to a younger clientele. Whatever tractor chosen will be produced for the next 4 years, after which time a reevaluation will be necessary. The PLE-Tough has passed through the concept and initial design phases and is ready for final design and manufacturing. Final development costs are estimated to be $750,000, and the new fixed costs for tooling and manufacturing are estimated to be $6 million. The PLE-Tough is expected to sell for $4,200. The first year sales for the PLE-Tough is estimated to be 4,000, with a sales growth for the subsequent years of 6% per year. The variable cost per vehicle is uncertain until the design and supply-chain decisions are finalized, but is estimated to be $2,300. Next-year sales for the PLE-Classic are estimated to be 3,800, but the sales are expected to decrease at a rate of 10% for each of the next 3 years. The selling price is $3,800. Variable costs per vehicle are $2,140. Since the model has been in production, the fixed costs for development have already been recovered.
a. Develop a 4-year financial model to recommend the best decision using a net present value discount rate of 10%. Include the discount rate as an input variable in your model.
b. What is the best decision using a net present value discount rate of 10%? What is the best decision using a net present value discount rate of 25%?
c. Use Goal Seek to find how sensitive the best decision (discount rate of 10%) is to the estimated variable cost of the PEL-Tough. In other words, what is the maximum acceptable variable cost for the PEL-Tough such that the PEL-Tough is the product of choice?
d. Construct a tornado chart and explain the sensitivity of each of the model’s parameters on the difference in net present value.