A Case Study on Automotive Battery System Design - Title Page - MIT

action; the analyst continues to develop a passive model of future conditions. Management willnot respond to future conditions in the model.Once the uncertainty analysis has been completed, the real options analyst will begin to developtest cases for “actions”. In other words, if demand for a new product falls to 50% of the originalprojection, a manager would close down the product, zeroing future cost associated withmanufacturing, marketing, etc.. By acknowledging this action, the real options NPV analystbegins to establish thresholds over the Monte Carlo simulation where the product will be shutdown, thus protecting the manufacturer against downside risk. If expected demand in year 5 is10,000, and simulated demand in year 5 is 10, the manager would shut down production. Thereis a cost to shut down, but that will most likely be substantially lower than the cost of continuedproduction due to both fixed and recurring costs. The analyst can establish the value of the shutdown cases and run screening models to evaluate them. For a real option, the analyst willexamine where flexibility in the system may be placed to enhance the ability to shut down.On the other hand, demand may be much higher than anticipated and the manager will want toexpand. In the original analyst’s passive model, there may have been variable cost due toeconomies of scale. In this new model, the analyst must also acknowledge expansion of either amanufacturing facility or the cost of an additional contract manufacturer. By establishing theability to produce beyond the originally expected value, the analyst has created upside potential.If we build the facility to product 10,000 units in year 5, but demand in the simulation is 20,000units, the additional potential revenue is lost unless there is an embedded method for expansion.If we want to limit downside losses and create upside potential, are there any actions that can betaken now to create an easier path for either(de Neufville & Scholtes, Flexibility in EngineeringDesign, 2011)?23