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the um reason why we developed this tool
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was because uh the world is getting more
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uncertain and it's getting more
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uncertain every day and managers are
00:00:20
faced with how do I make investments in
00:00:21
the face of this uncertainty not only
00:00:24
that competition is on the increase and
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so any investment that I make today uh
00:00:31
is going to get eventually get attacked
00:00:32
by competition if it's profitable and
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I'm going to see my my profits erode
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over time so we have these two levels of
00:00:39
uncertainty one is whether we're going
00:00:41
to be able to get the costs and revenues
00:00:43
that we uh anticipated and then the
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second one is how long we're going to be
00:00:46
able to do it and we developed this tool
00:00:49
that takes into account that sort of
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competitive wave with the overlay of
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uncertainty now this competitive wave as
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you can see in the first chart
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um and first graphic is uh comprises uh
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you know four pieces launch from the
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time that you think of making the
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investment until the time You' actually
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got the operation going to where You' be
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getting sales so this is where you're
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putting your money in then you have a
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ramp up you start off with relatively
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low sales and that kind of ramps up to
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either a steady growth condition or a
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steady state condition once you've got
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through the ramp up period is your
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exploit exploitation period
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and this is the time that you you're
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making your money but uh alas Along
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Comes competition and in the erosion
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period competitors enter and they erode
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away whatever profits you have and your
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challenge then is to come up with the
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next
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investment uh what we want to try to do
00:01:48
is give managers tools to very rapidly
00:01:51
uh and easily assess uh whether whether
00:01:54
an investment is worth pursuing or not
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and we allow them to input the the
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basically 11 pieces of data and very
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rapidly assess what the net present
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value is the total value uh discounting
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all your cash flows over time of that
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investment so let's have a look at how
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this works in the next graphic we show
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you the judgments on timing dimensions
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and as you can see here in this
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particular project management or the
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people who did the first plan have uh
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two years for launch they have three
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years for the ramp up they have four
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years for competitive impact and then
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after 14 years uh the the competition
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has eroded away all the profits and you
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better be on to something else or I'll
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see you in bankruptcy
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court uh and that's a judgment we we
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have to use managerial judgment to make
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our best estimates of what those timings
00:02:48
are and uh what I want to try to stress
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here is that the purpose of this tool is
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to help you be roughly right rather than
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what I say is precisely wrong you don't
00:02:59
want to be wrong to four decimal places
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you want a pretty good idea of what this
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investment's worth and the places where
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you can be uh you need to be most
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sensitive uh to the uh uh being wrong
00:03:11
you can't be right but you you you can
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worry about and work on how to make
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yourself roughly
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right in the next chart we look at the
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investment profile we uh have put in a
00:03:22
cost of capital of 25% this is the money
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that uh the market charges you to to
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provide you with capital either in the
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for of equity or debt and you better
00:03:32
deliver a better return than that
00:03:34
otherwise the Market's going to walk
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away from you and with an uncertain
00:03:37
Venture you're going to be expecting
00:03:39
that uh cost of capital to be pretty
00:03:41
darwn high in this particular project
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they asking
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25% and then what you have is a number
00:03:47
of investment decisions now the
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investment can take one of two
00:03:51
conditions one is where I just keep on
00:03:53
putting in money like maintaining a
00:03:55
research team or running a research lab
00:03:57
or whatever the case may be and then
00:03:59
second one is tranches of investment
00:04:01
that I put in say to build a pilot plant
00:04:03
or build a plant or buy the land and the
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way this is structured you get three
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shots at the U investment in in in in
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lump sums 500,000 at the start uh a
00:04:15
million after 6 months and 2 million
00:04:18
after 18 months and uh this then
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specifies when you're putting money in
00:04:23
in the launch phase hopefully very soon
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after that you start selling and the
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ramp up stay starts and that's uh the
00:04:30
second uh sorry the next
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graphic and what we're looking at here
00:04:35
is under steady state conditions uh what
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are the main drivers of revenues and
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costs as you can see uh in this
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particular project they're putting in
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about $7 million uh in fixed costs a
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year there's a maximum demand rate uh in
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units per year uh of
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50,000 there's a variable production
00:04:56
cost of $150 per unit for each one that
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you sell and there's a sales revenue or
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price that you get of
00:05:02
$400 in addition to this when you ramp
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up your project you also have to build
00:05:06
up inventory and receiv receivables and
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that's part of your investment and in
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this particular project they estimated
00:05:12
that about 33% of the uh revenues that
00:05:15
the compan is making is going to appear
00:05:17
either as inventory or
00:05:19
receivables so that's your operations
00:05:22
condition and now what we can do is do
00:05:24
the valuation now what this little
00:05:26
software does is it takes all those data
00:05:29
it estimat Ates the net present value of
00:05:31
that whole profile over time in micros
00:05:34
seconds and uh it allows you to get on
00:05:36
with discussing what you uh your
00:05:39
sensitivity and and and what you agree
00:05:41
or disagree with with respect to those
00:05:43
initial inputs notice I'm not concerned
00:05:46
about being right here because I know
00:05:47
I'm wrong uncertain Investments are
00:05:49
wrong and so what I'm going to be doing
00:05:52
is uh working with the team to help them
00:05:55
help me think where uh they would like
00:05:57
to change the input data and what I try
00:06:00
to do in a project like this is bring on
00:06:02
board people with different kinds of
00:06:04
expertise that I respect and the deal
00:06:07
that I cut with them is that if there's
00:06:08
any number that they think is wrong they
00:06:10
need to tell me now not later and they
00:06:13
need to give me a best alternative
00:06:14
number and the reason why so we can
00:06:17
listen to the presentation uh of what
00:06:20
people have to say and together make a
00:06:22
judgment as to what uh the most
00:06:24
appropriate number might be and notice
00:06:27
it now becomes their plan or our plan
00:06:30
and not just my
00:06:32
plan uh in this particular case as you
00:06:34
can see at the bottom of the graphic uh
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if those numbers pan out like I
00:06:38
initially put in you have a
00:06:41
$330,000 Net Present Value positive uh
00:06:45
which if you think about it is a little
00:06:46
bit tricky because if you look up at the
00:06:48
uh launch phase we putting about $3
00:06:50
million into this project and we only
00:06:53
getting 330,000 out so technically you
00:06:57
know what I should do is invest but the
00:06:59
reality is that little much little by
00:07:01
way of return is a is an awful little
00:07:03
return in the face of the big investment
00:07:05
that you're making so I would treat this
00:07:07
right away is at risk which means I now
00:07:10
need to do some sensitivity analysis and
00:07:13
once again these sensitivity analysis
00:07:15
can be done in micros seconds so let's
00:07:17
say we got into a discussion if you have
00:07:19
a look at the next chart about the cost
00:07:21
of capital and someone or the group
00:07:23
group agrees that you know given the
00:07:25
riskiness of this project it should be
00:07:26
even higher if you put in 30% return
00:07:29
return uh required as opposed to
00:07:32
25% uh your Net Present Value goes
00:07:35
straight south from a
00:07:37
$300,000 positive to a $715,000
00:07:41
negative so this project is very very
00:07:44
sensitive to cost of
00:07:46
capital alternatively if we look at the
00:07:48
next graphic what happens if we delay
00:07:50
the project in this particular case and
00:07:52
this actually in actually happened in a
00:07:54
real case recently management wanted to
00:07:57
delay the project by 6 months while they
00:07:59
made up the their minds and we said well
00:08:01
let's put in what the impact is going to
00:08:02
be of delaying firstly the uh ramp up
00:08:05
time because we're going to wait longer
00:08:07
to ramp up and then secondly delaying
00:08:09
the exploitation time because it's going
00:08:11
to take longer to to get exploitation
00:08:13
and of course competition is not going
00:08:15
to let you off so they're going to come
00:08:17
in you know just as as soon and that
00:08:19
basically means is if you sit diddling
00:08:21
around for 6 months trying to make up
00:08:23
your mind your project goes from a
00:08:25
$330,000 positive to a $693,000
00:08:30
negative and so this is the cost of
00:08:34
indecision a place where you often
00:08:36
worried about being wrong is you know
00:08:38
will we get the demand that we
00:08:39
anticipated and here what you can see is
00:08:41
that we're going to move from 50,000
00:08:44
units down to 45,000 units and if that
00:08:48
happens and we don't achieve our demand
00:08:50
uh we're suddenly going to go to a
00:08:52
negative uh $1.2 million so one of the
00:08:56
things I'd be really worried about with
00:08:57
this project is to spend some time I'm
00:08:59
getting better estimates of what the
00:09:01
demand might be before I start throwing
00:09:03
big money at the project and I'd rather
00:09:06
spend a couple of hundred th000 to find
00:09:08
I was dead wrong and to spend $35
00:09:10
million to find out I was dead
00:09:13
wrong finally uh what we might be
00:09:15
concerned about is how quickly are the
00:09:17
competitors going to respond and this is
00:09:19
increasingly a problem for uh people
00:09:22
today is competition is getting really
00:09:24
aggressive and they come in from all
00:09:26
parts of the world so in this particular
00:09:28
case what said is what happens if these
00:09:30
guys come in and start eating our lunch
00:09:33
after 3.5 years instead of four years
00:09:36
and as you can see what that does is it
00:09:39
uh takes away your positive Net Present
00:09:41
Value and gives you a modest negative
00:09:44
but uh overall what we've been able to
00:09:46
do now is very rapidly uh input
00:09:48
management judgments about what the
00:09:50
appropriate numbers might be and then do
00:09:53
very very rapid sensitivity analysis of
00:09:56
the outcomes that we get and we can also
00:09:59
now take this project and compare it to
00:10:00
other projects so that we can choose the
00:10:03
projects that seem to have the best bang
00:10:05
for the buck in terms of Net Present
00:10:07
Value in relation to initial investment
00:10:10
[Music]
