Part A (maximum 1500 words)
This part emphasises on the use of a DSS tool, and students are required to demonstrate proficiency with Visual DSSTM (a DSS development language/DSS generator).
Solve Questions 1, 2 and 3 using VISUAL DSSTM.
Question 1
Ciscomic Pty Ltd is a software development company located in Sydney. The company is planning to introduce a new mobile application software into the market. However, in recent times the company has made some bad investment decisions which in turn have impacted their profit bottom line. Thus the senior management requires a thorough analysis of every new product that is introduced to the market. As a senior business analyst, you have been appointed to advise the senior management on the feasibility of the new product.
An initial analysis conducted by other analysts for the product claim the anticipated net present value (NPV) for the new product line is over $2 million and they have recommended the manufacture of the product based on this assessment.
Your task is to use a decision support system (DSS) and report to the senior management on whether the claim of the NPV being over $2.5 million is correct or incorrect using the relevant information given in Table 1.
Table 1: Summarised product details
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Cost of production: $31.00 per unit
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Annual overhead cost: $210,000
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Initial investment needed: $1,850,000
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Estimated selling price: $55.00 per unit
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Market at time of introduction: 420,000 units per year
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Market growth: 15% per year
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Market share: Most likely 10%
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Assumed economically useful lifetime: 4 years, commencing 2017
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Discount rate used to analyse new product proposals is 12%
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You need to assume that the overhead and initial investment occurs at the START of the respective year, profit occurs at the END of the year and initial investment was only applicable to the first year.
Your task:
1. Develop a decision support model using Visual DSS using the variables described above. Include comments within your Visual DSS model to explain the variables and your calculations.
2. Based on the result of your model, what is the net present value (NPV)? Explain whether the claim regarding the NPV being above $2 million is correct or incorrect.
Hints
- Note that overhead and initial investment both occur at the START of the respective year, and profit occurs at the END of the year.
- You should use the correct NPV formula in Visual DSS. Use the ‘Help' feature within the Visual DSS application and Visual DSS tutorial to learn more about the correct NPV formula which is applicable to the scenario described in Question 1.
- Initial investment is a start up cost applicable to the first period only (i.e. 2017).
- The NPV is only relevant for the first period (i.e. 2017) for the purpose of decision making - so only report it for that period. Using NPV(0) in Visual DSS will allow you to achieve this.
Question 2
You are now asked to analyse the variations on the impact of market share, cost of producing, overheads and initial investment on the NPV. You need to conduct a risk analysis based on the information below:
a) Market share: could be as low as 5% or as high as 15%, but is most likely to be 10%. The distribution could be represented using a triangular distribution.
b) Unit costs can be described by normal distribution - mean of $30.00 and standard deviation of $5.00.
c) Overhead: could be as low as $150,000 per year or as high as $315,000 per year, but is most likely to be $210,000 per year. The distribution could be represented using a triangular distribution.
d) Initial investment requirements can be uniformly distributed between $1,500,000 and $2,500,000.
The senior management decided on the following decision criteria:
Decision criteria: The company is unwilling to proceed if there is a 20% or greater chance that the net present value will be less than $1,000,000 (1 million).
Your task:
1. You are required to use Visual DSS to run a Monte Carlo simulation (a Risk Analysis).
2. Produce a cumulative probabilities report and graph for the above question. Based on results and the decision criteria, explain whether the senior management should accept or reject the proposed production of the product.
Question 3
When the above analysis reached the Chief Executive Officer (CEO) of your company, he became very concerned about the assumptions made in the model. His experience has taught him to consider the uncertainty associated with selling price and production costs more thoroughly. He required further analysis to be done by incorporating the following uncertainties to Question 1 model:
a) Selling price: uniformly distributed between $75 and $45.
b) Unit costs: normally distributed, mean of $30.00, standard deviation of $10.00.
He applied different decision criteria and was willing to go ahead with the product proposal if there was at least an 80% chance the net present value would be greater than $1,000,000.
Your task:
1. You are required to use Visual DSS to run a Monte Carlo simulation (a Risk Analysis). Based on your results determine whether the CEO will proceed under these uncertainties.
2. Produce a cumulative probabilities report and graph for the question. Based on results and the decision criteria, will the CEO accept or reject the proposed production of the product?