Sep 21, 2017 term paper 2

# DORD MOTORS QUESTION

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Dord motors is considering whether to introduce a new sports car model namedthe Racer. The management is trying to assess the prospects for this new model. While understanding the project’s profitability is a difficult task, it is an important task before the project is taken up. For this purpose, they have put together estimates for fixed and variable costs, projected future sales and prices at which they intend to sell this model. Each of these projects features are described in a model, as follows.

– Thefixed costof developingThe Racer is equally likely to be \$3 or \$5 billion. At an upfront expense of \$200,000, the management can acquire additional information that helps narrow the fixed cost to be equally at either \$3.5 or \$ 4.5 billion.

– Variable cost per car manufacturedis equally likely to be \$5000, \$6000, \$7000 or \$8000 during year 1 and it is assumed to increase by 5% each year. Here again the management has an option to incur an upfront expense of \$100,000 to narrow the first year variable cost per car to be equally likely at either \$6000 or \$7000.

– Year 1salesare normally distributed withmean 200000 andstandard deviation 50000. Year 2 sales are normally distributed with mean equal to actual year 1 sales and standard deviation 50000. Year 3 sales are normally distributed with mean equal to actual year 2 sales and standard deviation 50000. An advertising company has advised that an ad-campaign can help increase the first year sales, where it proposes a 5000 increase in first year mean sales for every additional \$100,000 spent on the campaign. After \$100,0000 spent on the ad-campaign, the market is expected to saturate and no further increase in first year sales would be possible.

– Theselling pricein year 1 is \$13000. Years 2 and 3 prices will be determined based on the previous year’s price and sales. Specifically, year 2 price = 1.05*(year 1 price) + \$30*(percentage by which year 1 sales exceed expected year 1 sales), year 3 price = 1.05 * (year 2 price) + \$30*(percentage by which year 2 sales exceed expected year 2 sales).

Your goal is to estimatethe NPV of the new car during its first 3 years.

· Assume that cash flows are discounted at 10%.

· Simulate 1000 trials and estimate the mean and the standard deviation of the NPV for the first 3 years of sales.

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