BareBones NPV Evaluation Software
User Guide
Created in 2005 by Adrian Becker, Lee Tobey and Justin Sapolsky
BareBones Real Options Software Table of Contents
Introduction...... 1 Step-by-Step Example...... 2 Sea Products Project...... 2 Sea Products Illustrative Table...... 3 Sea Products Walk Through...... 4 Using the BareBones Real Options Software...... 6 Entering Stage 1 Estimates...... 6 Initial Investment at Launch...... 6 Years from Today to Project Launch...... 6 Project Fixed Costs per Year...... 6 Project Fixed Revenues per Year...... 6 Entering Stage 2 Estimates...... 6 Annual Variable Cost in Stead State...... 6 Annual Variable Revenue in Steady State...... 6 Entering Stage 3 and 4 Estimates...... 7 Number of Years from Launch to Steady State...... 7 Project Lifespan (From Launch to Termination)...... 7 Number of Years from Launch to Competitive Entrance...... 7 Entering Rate of Return Estimates...... 7 Project Rate of Return...... 7 NPV Graph...... 8
BareBones Real Options Software Introduction
The BareBones Real Options tool provides users with a fast, straightforward method of calculating the net present value and real option value of a project. The software builds these estimates using a method based on yearly business milestones, along with revenue and cost assumptions. The user-defined assumptions are then entered into a mathematical distribution that outputs the NPV and Real Options values. NOTE: Some references in this tutorial refer to the more advanced version of this program, BareBones Real Options.
Figure 1.1 Introduction Screen
In addition to the ability to analyze the NPV for a project, the BareBones Real Options tool allows you to define uncertain parameters on the Intermediate-Advanced sheet and obtain Real Option value.
BareBones Real Options Software 1 Step-by-Step Example
Sea Products Project
We will illustrate the use of this software through a sample project, named Sea Products.
Sea Products is considering a project with the following characteristics:
Before launching, the company must take out a license for $5 million to obtain exclusive use of a new technology. They must also build a pilot plant for $10 million.
If the product passes regulatory approval, the company can be ready to start sales in 1 ¼ years.
It will take one additional year to ramp up revenues to full potential.
Full variable revenues are assumed to be $40 million per year.
Full variable costs are assumed to be $36 million per year.
Full fixed revenues are assumed to be $2 million per year.
Full fixed costs are assumed to be $1.8 million per year.
The bad news is that competition does not sleep at the wheel, and we can expect competitive erosion to start within four years of launch.
We can expect margins to be gone in eighteen years.
The risk-free rate for Sea Products’ investments is 5%.
BareBones Real Options Software 2 Sea Products Illustrative Table
1) Take out a $5 million license and build 1) Initial Investment = $15 million. a $10 million pilot plant.
2) Begin sales in 1 ¼ years. 2) Years to launch = 1.25
3) Needs an additional year to ramp up. 3) Launch to ramp-up = 2.25
4) Full variable revenues are assumed to 4) Steady state variable revenues = $40 be $40 million per year. million.
5) Full variable costs are assumed to be 5) Steady state variable costs = $36 $36 million per year. million.
6) Full fixed revenues are assumed to be 6) Steady state fixed revenues = $2 $2 million per year. million
7) Full fixed costs are assumed to be $1.8 7) Steady state fixed costs = $1.8 million million per year.
8) Competitive erosion will begin 4 years 8) Launch to competitive entrance = 4 after launch.
9) Margins will be gone in 18 years. 9) Project Lifespan = 18
10) The risk-free rate of investments is 5%. 10) Rate of Return = .05
BareBones Real Options Software 3 Sea Products Walk Through-Basic
Task Exercise
1. Calculating □ GOAL: To calculate NPV for a project using yearly milestones, revenues, and costs. NPV
STEP 1 Open the BareBones Real Options workbook and select the Basic NPV worksheet.
STEP 2 Enter estimates for the required investment, fixed costs, fixed revenues and time of the product launch.
STEP 3 Enter estimates for your steady state parameters.
STEP 4 Estimate the number of years from the product launch to competitive entrance and product termination.
STEP 5 Estimate rate of return for the project.
BareBones Real Options Software 4 Task Exercise
STEP 6 The NVP will automatically be calculated as long as your license is valid.
STEP 7 View the Steady State Expectation Profile Graph. This will show you the expected profits for each year of the project.
BareBones Real Options Software 5 Using the BareBones Real Options Software
Entering Initial Investment and Fixed Cost and Revenue Data
Upon opening the program, there are 10 assumptions that must be input before the NPV can be calculated. The following stage 1 parameters are located at the top of the spreadsheet:
Initial Investment at Launch The initial cost of investment in the project.
The time from the initial investment date to Years to From Today to Project Launch the first sales.
Project Fixed Costs per Year Estimated fixed costs per year.
Project Fixed Revenues per Year Estimated fixed revenues per year.
Figure 2.1 Initial Investment and Fixed Cost Data
Entering Steady State Parameters
Refer to Stage 2 of the worksheet. The assumptions here define the context for the variable costs and revenues, and build a framework for the accurate calculation of NPV. The input boxes are as follows:
Number of Years from Launch to Steady The time from launch date to the time when State stable, peak revenues are achieved. Annual Variable Costs in Steady State Variable costs once variable profits have leveled Annual Variable Revenues in Steady State Variable revenues once variable profits have leveled
BareBones Real Options Software 6 Figure 2.2 Steady State Parameter Estimates
Competitive Entrance and Lifespan
Refer to Stage 3 of the worksheet. The assumptions here determine how long the firm will experience full revenues before competitive entrance and how long the project will last before termination. The input boxes are as follows: The time from launch date to the end of the Project Lifespan project. The time from launch date to the first Launch to Competitive Entrance entrance of competitors.
Rate of Return The return achieved on re-invested profits.
Figure 2.3 Competitive entrance and lifespan
Rate of Return
Refer to Stage 4 of the worksheet. This assumption will determine the current value of a dollar received during each year of the projects life. The input box is as follows:
Rate of Return The return achieved on re-invested profits.
Figure 2.4 Rate of Return
After the input boxes must be filled in, press the Calculate button to obtain valuation.
BareBones Real Options Software 7 NPV Graph
A graph will also appear. This graph illustrates the expected profits for each year of the project, which are the numbers used to calculate the NPV.
Figure 2.5 Steady State Expectation Profile – Basic and Intermediate/Complete/Advanced Views
BareBones Real Options Software 8