Whirlpool Europe Analysis

Whirlpool Europe Analysis

The Whirlpool Europe case provides an opportunity to look at different ways to evaluate a major IT investment the company is considering. To undertake this analysis we have to make a few assumptions because the case does not have all the details needed to estimate benefits and investment cost. However, if you were in a company faced with this situation, these numbers would be available.

The spreadsheet for Whirlpool contains two worksheets. Worksheet 1 is a net present value analysis, and worksheet 2 applies an options pricing model to the decision.

Be sure to save a copy of the spreadsheet when you download it because most of the questions refer back to the original spreadsheet, which you will often change in a preceding question.

NPV Analysis (Worksheet 1)

The NPV analysis follows the scenario in the case: the company invests for a series of years, and implements in the West, South Central and North regions in that order. The spreadsheet has been designed with the first analysis showing the summary of investment costs and anticipated benefits for the six year time horizon in the case. The spreadsheet calculates the net present value of each year’s benefits and costs, and subtracts the NPV of costs from benefits. The table just below this analysis contains variables that you can change to test the sensitivity of the analysis. The rest of the spreadsheet presents the details of the assumptions and calculations to arrive at the yearly costs and benefits.

Please answer the following question about the NPV analysis:

1. What are the key assumptions of this analysis?

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2. The current NPV is negative. One way to save money would be to reduce consulting costs. Please set the average consulting cost per month in cell b33 to $5000. At what discount rate is the NPV for the project 0?_________

3. Returning the consulting cost to $15,400 per month, at the original discount rate of .09, what is the impact on NPV if you double the number of employees participating in the project?

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4. Returning the number of employees participating to 200, what is the impact on NPV if the consulting fee turns out to be $20,000 per month?

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5. Returning the consulting salary to $15,400 per month, what is the impact on NPV of doubling the number of consultants required each month?

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6. Returning to the original staffing levels for consultants, how much more than estimated do the benefits have to be to make the project attractive? To answer this question, use the benefits adjustment factor in the “Key Factors to Manipulate” table.

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Options Pricing Analysis (Worksheet 2)

The options pricing analysis applies real options theory to the evaluation of an IT project. Suppose that SAP, sensing some hesitation on Whirlpool’s part, makes the following offer. Instead of committing to the SAP project in total, SAP proposes to management that Whirlpool implement 6 to 8 modules of the entire system at a plant in the U.K. The software company and Whirlpool’s IT staff working together figure the total cost of this effort including payment to SAP, Whirlpool staff time and consultants, at $4 million for 1999.

At the end of this pilot test, Whirlpool would decide whether or not to proceed with full scale implementation of SAP in all four European regions. Just as with the earlier analysis, we have to make some assumptions. Worksheet 2 uses the data from worksheet 1 to restate the costs and benefits for the option which involves only the South, Central and Northern regions.

On worksheet 2, the analysis uses the Black Scholes options pricing model (OPM) to calculate the value of this option to make a decision at the end of a pilot test in the West. For a real option, x in the OPM formula is the expected revenue from the project, and c, the exercise price, is the IT investment required for the SAP project.

Please answer the following questions about the OPM analysis:

7. What are you buying an option to do?

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8. Given an option cost of $4 million and the value of the option in worksheet 2, should Whirlpool proceed or abandon the project? ______________

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9. Suppose that Whirlpool finds a way to reduce the costs of the project by 5%. Please change the cost factor in cell G31 to 95%. What is the value of the option now?

¬¬¬¬¬¬¬¬¬¬¬¬¬¬¬¬¬¬¬¬________________. Would you proceed with the pilot under these costs? ________

10. Returning the cost factor to 100%, what happens to the value of the option if the risk free interest rate doubles to 8%?

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11. Returning the risk free rate to 4%, what happens to the value of the option if the Whirlpool’s cost of capital goes from 9% to 15%?

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12. Please return the cost of capital to 9%. Sigma squared is the variance in the rate of return of the project. The calculations for the variance are in the first table of worksheet 2. Determining sigma squared is one of the most challenging tasks in calculating the value of a real option. In this example, we suggest asking managers for their best and worst case estimates of the benefits, given the expected benefits taken from worksheet 1. Just above the table, there is a percentage number for the range surrounding the expected returns, which starts at 20%. This says that the worst estimate is 80% of the expected, and the best is 120% of the expected.

a. What happens to the value of the option if you change the range from 20% to 10%?

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b. What happens to the value of the option if you change it to 30%?

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c. What do these changes say about the sensitivity of OPM and its applicability to IT projects?

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