Lecture12 - MBAC6080 Decision Modeling and Applications...

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1 MBAC6080 Thomas Vossen Assistant professor of Operations Management Leeds School of Business University of Colorado Boulder, CO 80309-0419 Decision Modeling and Applications
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Lecture 12, 4-9-2008 2 MBAC6080 Agenda Simulation - Example: Valuing Netscape - Example: Pricing Options - Example: Project Management - Example: Portfolio Allocation Calambra Case
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Lecture 12, 4-9-2008 3 MBAC6080 Simulation Simulation: a descriptive technique that enables a decision maker to evaluate the behavior of a model under various conditions. - Simulation models complex situations - Models are simple to use and understand - Models can play “what if” experiments - Extensive software packages available
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Lecture 12, 4-9-2008 4 MBAC6080 Analytic models: values of decision variables are the outputs. Simulation models: values of decision variables are the inputs. - Investigate the impacts on certain parameters when these values change. Simulation
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Lecture 12, 4-9-2008 5 MBAC6080 Simulation Modeling Process Selecting uncertain parameters Level of uncertainty, Sensitivity of results Selecting probability distributions Empirical data, Expert judgment Selecting outputs Can choose as many as we want without increasing complexity Setting up and running a simulation Number of trials depends on the desired precision Analyzing the results The result for each output is a distribution Precision of estimates can be measured by confidence intervals
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Lecture 12, 4-9-2008 6 MBAC6080 Example: Valuing Netscape
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Lecture 12, 4-9-2008 7 MBAC6080 Valuing Netscape The initial public offering (IPO) of Netscape Communications Corporation on August 9, 1995, is thought to have signaled the beginning of the Internet boom. - The underwriters of the IPO planned to offer five million shares at $28 per share, thereby raising $140 million. - Up to that point, about $27 million had been invested in Netscape, and the company had yet to show a profit. - At $28 per share, Netscape’s market value would be more than $1 billion, despite a book value of just $16 million.
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Lecture 12, 4-9-2008 8 MBAC6080 Valuing Netscape (ctd.) IPO underwriters calculated value of the firm by adding the present value of the free cash flows through 2005 to the present value of the firm after 2005. This latter value, known as the terminal value, was calculated under the assumption that the free cash flows after 2005 would grow forever at a constant rate.
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Lecture 12, 4-9-2008 9 MBAC6080 Valuing Netscape: Assumptions Annual revenue growth rate of 65 percent, terminal value growth rate of 4 percent, and the tax rate at 34 percent. Other assumptions included: Cost of sales: 10.4% of revenues R&D: 36.8% of revenues Depreciation: 5.5% of revenues Operating expenses: 80% of revenues in 1995 decreasing to 20% by 2005 Capital expenses: 45% of revenues in 1995 decreasing to 10% by 2005 See Excel File: Netscape.xls
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Lecture 12, 4-9-2008 10 MBAC6080 Measures of Value NPV - more than $1 billion given assumptions Terminal value / Total present value - Over 75% Year cash flows first turn positive - 2002 given assumptions Maximum loss
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Lecture12 - MBAC6080 Decision Modeling and Applications...

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