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Whirlpool Europe - NPV Analysis

Cost of Capital

COSTS (in Millions)


Cap. Equipment
Software Licences
Consulting Cost
Employee Cost (200 employees, avg. salary=45K)
Task force cost
Maintenance Expense
Licence Maintenance Fee
TOTAL
NPV
NPV of COSTS

0.09
1999

2000

2001

2002

4.3
0.6
3.5
2.3

8.6
0.3
1.7
4.5
0.3
1.2
0.1
16.7
14.0

6.9

4.1

1.3
6.8
0.6
1.8
0.2
17.5
13.5

3.7
0.9
0.6
5.2
4.4

8.6
1.8
1.7
12.1
9.4

0.6
11.3
10.3
54.9

SAVINGS (in Milions)


Inventory Savings
Revenue and Margin Improvements
Other Expense Savings
TOTAL
NPV
NPV of BENEFITS

0.0
0.0
46.6

NET NPV (in Millions)

(8.2)

Key Factors to Manipulate


Avg salary/employee
Number of participating Employees
Months in a year
Cost per consultant per month

2003

2004

0.7
9.0
0.6
2.4
0.3
17.1
12.1

0.6
3.0
0.4
4.0
2.6

0.3
3.0
0.4
3.7
2.2

10.1
4.0
2.5
16.7
11.8

6.7
6.8
3.3
16.8
10.9

3.8
9.9
3.4
17.1
10.2

Assumptions
45,000 Employee cost: average salary per employee (involved in implementation) =100k
200 Number of participating employees: 50 employees per each of the 4 waves.
12
15,400 Consulting Cost: 15,400 per month (per consultant) as stated in case.

Avg fee/consultant (per annum)

184,800

Number of Consultants -

19
2000

2001

2002

4
1.00

Benefits adjustment factor


INTERMEDIATE CALCULATIONS

Calculations for revenue margin improvements


Due to ERP implementation,

A) the profit margin improves (.25% or .0025 by the second year after implementation, refer page 3 and exhibit 5) and
B) the product availability will improve (projected/targeted availability=92%) and 25% of increase in availability will be
converted into sales (refer page 3 and exhibit 4).
To find out the the additional revenues due to ERP implementation, we need to find out: ( Assumption is that without ERP
implementation, total units sold in future would have been constant i.e at the same level)
1) additional revenue due to increase in profit margin - to calculate this, multiply "increase in profit margin" by the "number of
units sold at present" (i.e. before ERP implementation)
2) Revenue coming from additional sales of products - to calculate this, multiply"the number of additional units sold" by the
"profit margin"
First of all we find out the avg. price of products
Product Price
Tot. Rev. (1997) - all regions
Tot. Units Sold (1997) - all regions
Avg. Price per Unit (1997) - all regions

Explanation
1,227,859,000 Adding revenues from all the regions (exhibit 5)
6,107,909 Adding units sold in all the regions (exhibit 4)
201 Arrived at the average price by dividing total revenue by total units sold.
(This assumption should not make a difference in the analysis as this avg.
price has been used later to forecast the aggregate revenues.)

Assumptions regarding Exhibit 4:


Assumption: projected/targeted availability=92%, Total desired/expected increase will occur between 2000 and 2005.
E.g. for region "west" the additional % increase over next 5 years will be (92-73.5)= 18.5%. Now, in 2000, we achieve 25% of
this 18.5. Therefore, expected % increase in availability (.25*18.5) = 4.625%. This percentage is multiplied by the "current
number of units sold" to arrive at the increased availability in terms of number of units.
Assuming that we can sell 25% of this additional product, we multiply the units obtained (from previous calculation) by the
average price of product (calculated above) to arrive at the additional revenue from increased sales (due to increased
availability)
Note: Alternative method to find the profits due to additional sales: We can instead of calculating average price, use the unit
profit margin figures (exhibit 4) along with margin improvement figures (exhibit 5). This would be a little more
complex/complicated but I think it would be a better way to deal with the problem. Comments???
Note 2: The additional availability will be cummulative. I.e year 2 will have increase= increase in year 1 + increase in year 2
Product Availability (in 000's)
Prod. Avail. 1997
West
South
Central
North

73.5
83.1
76.8
83.2

Percentage Availability Improvement by Wave


2000
2001
2002
0.25
0.4
0.35
0.35
0.4
0.4

2003

2004

0.25
0.4
0.4

0.2
0.4

Total expected % increase in availability

Units sold in 1997


18.5
8.9
15.2
8.8

2,271,139
1,415,949
977,665
1,443,156

2000
105,040
0
0
0

Additional product available


2001
2002
168,064
147,056
44,107
50,408
0
59,442
0
0

2003
0
31,505
59,442
50,799

2004
0
0
29,721
50,799

2000
105,040
0
0
0

(Cumulative) Additional product available


2001
2002
273,104
420,161
44,107
94,515
0
59,442
0
0

2003
420,161
126,019
118,884
50,799

2004
420,161
126,019
148,605
101,598

2000
26,260
0
0
0

(Cumulative) Additional product SOLD


2001
2002
68,276
105,040
11,027
23,629
0
14,861
0
0

2003
105,040
31,505
29,721
12,700

2004
105,040
31,505
37,151
25,400

Addition Revenue from Increased Availability


2000
2001
2002
2003
$5,278,997
$13,725,392
$21,115,987
$21,115,987
$0
$2,216,673
$4,750,013
$6,333,351
$0
$0
$2,987,374
$5,974,748
$0
$0
$0
$2,553,006

2004
$21,115,987
$6,333,351
$7,468,435
$5,106,013

Assumption: The margin improvement percentages (exhibit 5) are absolute increments (I.e not as a percentage of current margin percentage). For example, if current
margin is 12% and improvement in 2000 is .06%, we have assumed that total profit margin in 2000 would be 12.06%
Profit Margin 1997
Profit Margin
West
South
Central
North

2000
0.12
0.16
0.24
0.11

0.0006

Profit Margin Improvement


2001
2002
0.0025
0.001

0.0025
0.0025
0.0013

2003

2004

0.0025
0.0025
0.0025
0.0013

0.0025
0.0025
0.0025
0.0025

Additional Profit from Incr.Avail. (taking into account the increase in profit margins)
2000
2001
2002
2003

Total {A}

$636,647.02
$0.00
$0.00
$0.00
$636,647.02

$42,548.71
$2,216.67
$0.00
$0.00
$44,765.39

$105,579.94
$16,625.05
$3,883.59
$0.00
$126,088.57

$105,579.94
$31,666.76
$22,704.04
$3,318.91
$163,269.64

2004

$105,579.94
$31,666.76
$37,342.17
$19,402.85
$193,991.72

Assumption: Every year, the "current revenue" is multiplied by the "cumulative incremental margin" to arrive at the additional profits on the base revenue/(units sold)
Revenue
West
South
Central
North

1997
$477,784,000
$283,549,000
$185,625,000
$280,901,000

2000
0.0006

Profit Margin Improvement


2001
2002
0.0025
0.0025
0.001
0.0025
0.0013

2003
0.0025
0.0025
0.0025
0.0013

2004
0.0025
0.0025
0.0025
0.0025

Total {B}
Total Add. Profit {A} + {B}
In Millions

Addition Profit from Increased Profit Margin on the existing (base) sales
2000
2001
2002
2003
$286,670
$1,481,130
$2,675,590
$3,870,050
$0
$283,549
$992,422
$1,701,294
$0
$0
$241,313
$705,375
$0
$0
$0
$365,171
$286,670
$1,764,679
$3,909,324
$6,641,891
$923,317.42
$1

$1,809,444.79
$2

$4,035,412.97
$4

$6,805,160.34
$7

2004
$5,064,510
$2,410,167
$1,169,438
$1,067,424
$9,711,538
$9,905,529.92
$10

Calculations for Inventory Savings:


In the case, Aggregate inventory savings has been projected to be $34.3 M(pg. 3)
We have used exhibit 3 to support this projection. Explanation: DSI will improve by 12 days in all the regions. However this reduction will occur in phases. In
2000 there will be 3 days reduction (I.e. 20% improvement).
We multiply Inventory value per day (i.e. 1221) with the number of days saved and thus arrive at the savings in that region, for that year. Finally adding the
savings from all the regions we get the total savings for that year.
Acc. to our calculations the total inventory savings would be $ 32.9 M

Inventory Savings (in 000's)

2000
Projected Improvement of DSI (days) Inventory Value per Day (1997)
Improv. In DSI
12
1221
3
12
653
12
389
12
594
$3,663
$4

West
South
Central
North
Cummulative Savings
In Millions

Total units sold


west
south
central
north
Total units sold

2,271,139
1,415,949
977,665
1,443,156
6,107,909

0.75

2000
2001
2002
2003
2004

South
$0.00
$285,769.87
$1,009,051.35
$1,732,963.76
$2,441,833.26

2001

2002

4.8
4.2

4.2
4.8
4.8

2003

2004

2.4
4.8
$3,785
$4

Total
$450,000
$1,560,770
$3,129,252
$5,304,543
$7,289,227

$8,603
$9

$10,130
$10

3
4.8
4.8
$6,677
$7

Cost Savings by Region


Central
North
$0.00
$0.00
$0.00
$0.00
$245,200.89
$0.00
$728,083.84
$368,495.01
$1,206,782.07
$1,090,611.45

Sum
$0.00
$285,769.87
$1,254,252.23
$2,829,542.61
$4,739,226.78

Plus 75% other*


$
450,000
$
1,275,000
$
1,875,000
$
2,475,000
$
2,550,000

*Cost savings for South Central North for OPM analysis. Assume that 75% of other savings in case occurs in these three regtions
Calculated as {A}+{B}+ inventory savings

Black Scholes Model for Real IT Options

Applied to Whirlpool Case


Pilot in West, buying an option to implement in other 3 regions

w(x,t) value of project whose underlying risky


asset is the expected revenues from the project
x at time t
c is the exercise price= IT investment
x is expected revenues from the project
Assume benefits as listed below starting in one year. Managers have said to use
20% as the range around the expected return to get best and worst case estimates
Rate is each year's benefit/costs in table below. We
sum the variance of each year's estimates to estimate sigma squared.

r is compounded risk-free interest rate (T-bill rate)

% range of
returns

20%

t*-t is duration of the option


sigma -squared is the variance in the expected
return from the project
(1) w(x,t) = xN(d1)-c e(exp(-r(t*-t))N(d2)
N is cumulative normal density function
(2) d1= (ln(x/c)+(r+0.5 sigma-squared)(t*-t))/(sigma(sqrt(t*-t))

Benefits of exercising option Returns based on best, expected and worst case estimates by management; computations based on %
to implement in 3 regions
Expected
Worst
Best Rate/return-exp Rate/return wrst
Rate/return-bst
1999
0
2000
5,186,317
4,149,054
6,223,581
0.31
0.25
0.37
2001
12,112,845
9,690,276
14,535,414
0.69
0.55
0.83
2002
16,665,213
13,332,170
19,998,256
0.97
0.78
1.17
2003
16,782,560
13,426,048
20,139,072
4.20
3.36
5.03
2004
17,090,330
13,672,264
20,508,396
4.62
3.70
5.54
50,818,561
40,654,849
60,982,274
1.09
0.87
1.31
NPV in 2000 (Expected)

NPV in 2000 (Worst) NPV in 2000 (Best)

NPV(2000)/Exp.NPV(1 NPV(2000)/NPV(1999)

NPV of costs

$50,818,561
0.05
0.218

0.04
0.09
1

Computations
(2) d1= (ln(x/c)+(r+0.5 sigma-squared)(t*-t))/(sigma(sqrt(t*-t))

d1

(0.06)

(3) d2=(ln(x/c) + (r-0.5 sigma-squared)(t*-t))/(sigma(sqrt(t*-t))

d2

(0.28)

w(x,t) Value of the option

3,613,788

(1) w(x,t) = xN(d1)-c e(exp(-r(t*-t))N(d2)

46,622,533
0.048
0.218

% of original costs
100%

54,851,092

r
discount rate
Option duration t*-t

0.004
0.019
0.038
0.704
0.853
0.05

NPV(2000)/NPV(1999)

Expected NPV(1999), assuming 3 scenarios equally probable

NPV 2000-2004 x =expected value of returns


(3) d2=(ln(x/c) + (r-0.5 sigma-squared)(t*-t))/(sigma(sqrt(t*-t))
sigma-squared
sigma

Variance

1999
2000
2001
2002
2003
2004
NPV costs

Costs Wksht1*
11,261,200
16,663,200
17,543,600
17,139,200
4,000,000
3,700,000

Cost incurred
11,261,200
16,663,200
17,543,600
17,139,200
4,000,000
3,700,000
$54,851,092

Estimated Costs

1999
2000
0
5,186,317
Savings from Worksheet 1

2001
12,112,845

2002
16,665,213

2003
16,782,560

2004
17,090,330

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