Question

Handstar Inc was created a little over 4 years ago by two college roommates to develop apps for smartphones. It has since grown to ten employees with annual sales approaching $1.5 million. Handstar's original product was an expense report app that allowed users to record expenses on their smartphone and then export their expenses into a spreadsheet that then created an expense report in one of five standard formats. Based on the success of its first product, Handstar subsequently developed three additional apps: an app for tracking and measuring the performance of investment portfolios, a calendar app, and an email app.

The two founders of Handstar have recently become concerned about the competitiveness of the firm's offerings, particularly since none of them has been updated since their initial launch. Therefore, they asked the directors of product development and marketing to work together and prepare a list of potential projects for updating Handstar's current offerings as well as to develop ideas for additional apps. The directors were also asked to estimate the development costs of the various projects, product revenues, and the likelihood that Handstar could retain or obtain a leadership position for the given app. Also, with the increasing popularity of mobile computing, the founders asked the directors to evaluate the extent to which the products made use of the Web.

The product development and marketing directors identified three projects related to updating Handstar's existing products. There first project would integrate Handstar's current calendar app with its email app. Integrating these two apps into a single app would provide a number of benefits to users such as allowing them to automatically enter the dates of meetings into the calendar based on the content of an email message. The directors estimated that this project would require 1250 hours of software development time. Revenues in the first year of the product's launch were estimated to be $750,000. However, because the directors expected that a large percentage of the users would likely upgrade to this new product soon after its introduction, they projected that annual sales would decline by 10 percent annually in subsequent years. The directors speculated that Handstar was moderately likely to obtain a leadership position in email/calendar apps if this project were undertaken and felt this app made moderate use of the Web.

The second project related to updating the expense report app. The directors estimated that this project would require 400 hours of development time. Sales were estimated to be $250,000 in the first year and to increase 5 percent annually in subsequent years. The directors speculated that completing this project would almost certainly maintain Handstar's leadership position in the expense report category, although it made little use of the Web.

The last project enhancement project related to enhancing the existing portfolio tracking app. This project would require 750 hours of development time and would generate first-year sales of $500,000. Sales were projected to increase 5 percent annually in subsequent years. The directors felt this project would have a high probability of maintaining Handstar's leadership position in this category and the product would make moderate use of the Web.

The directors also identified three opportunities for new products. One project was the development of a spreadsheet app that could share files with spreadsheet programs written for PCs. Developing this app would require 2500 hours of development time. First-year sales were estimated to be $1,000,000 with an annual growth rate of 10%. While this app did not make use of the Web, the directors felt that Handstar had a moderate chance of obtaining a leadership position in this product category.

The second new product opportunity identified was an app for browsing the Web. Developing this app would require 1875 development hours. First-year sales was estimated to be $2,500,000 with an annual growth rate of 15%. Although this app made extensive use of the Web, the directors felt that there was a very low probability that Handstar could obtain a leadership position in this product category.

The final product opportunity identified was a trip planner app. This product would require 6250 hours of development time. First-year sales were projected to be $1,300,000 with an annual growth rate of 5%. Like the Web browser app, the directors felt that there was a low probability that Handstar could obtain a leadership position in this category, although the program would make extensive use of the Web.

In evaluating the projects, the founders believed it was reasonable to assume each product had a 3-year life. They also felt that a discount rate of 12% fairly reflected the company's cost of capital. An analysis of payroll records indicated that the cost of software developers is $52 per hour including salary and fringe benefits. Currently there are four software developers on staff, and each works 2500 hours per year.

Q1-Which projects would you recommend Handstar pursue based on the NPV approach?

Q2-Assume the founders weigh a projects NPV twice as much as both obtaining/retaining a leadership position and making use of the web. Use the weighted factor scoring method to rank these projects. Which projects would you recommend Handstar pursue?

Q3-In your opinion is having an additional software development engineer justified?

Answer 1

Assumptions-   Development is done only in the beginning, before the product could be taken to the market

Discount rate	12%
manhour rate	52
Available manhours	10,000
1
Project	Calendar+email
Manhours	1250
Development cost	65,000
Revenue rate	-10%
Revenue projections
Year	0	1	2	3
Cash flow	(65,000)	750,000	675,000	675,000
PV	(65,000)	669,643	538,106	480,452
NPV	1,623,200
2
Project	Expense report
Manhours	400
Development cost	20,800
Revenue rate	5%
Revenue projections
Year	0	1	2	3
Cash flow	(20,800)	250,000	262,500	262,500
PV	(20,800)	223,214	209,263	186,842
NPV	598,520
3
Project	Portfolio tracking
Manhours	750
Development cost	39,000
Revenue rate	5%
Revenue projections
Year	0	1	2	3
Cash flow	(39,000)	500,000	525,000	525,000
PV	(39,000)	446,429	418,527	373,685
NPV	1,199,640
4
Project	Spreadsheet app
Manhours	2500
Development cost	130,000
Revenue rate	10%
Revenue projections
Year	0	1	2	3
Cash flow	(130,000)	1,000,000	1,100,000	1,100,000
PV	(130,000)	892,857	876,913	782,958
NPV	2,422,729
5
Project	Browser app
Manhours	1875
Development cost	97,500
Revenue rate	15%
Revenue projections
Year	0	1	2	3
Cash flow	(97,500)	2,500,000	2,875,000	2,875,000
PV	(97,500)	2,232,143	2,291,932	2,046,368
NPV	6,472,943
6
Project	Trip planner app
Manhours	6250
Development cost	325,000
Revenue rate	5%
Revenue projections
Year	0	1	2	3
Cash flow	(325,000)	1,300,000	1,365,000	1,365,000
PV	(325,000)	1,160,714	1,088,170	971,580
NPV	2,895,464
Project	NPV	Manhours need
Calendar+email	1,623,200	1250
Expense report	598,520	400
Portfolio tracking	1,199,640	750
Spreadsheet app	2,422,729	2500
Browser app	6,472,943	1875
Trip planner app	2,895,464	6250
Project	NPV	Ranking based on NPV
Browser app	6,472,943	1
Trip planner app	2,895,464	2
Spreadsheet app	2,422,729	3
Calendar+email	1,623,200	4
Portfolio tracking	1,199,640	5
Expense report	598,520	6

If Handstar has to pursue only 1 project, it could go with the first project with highest NPV- Browser app. However, since the NPV of each project is +ve, it could ideally pursue all projects, in the order of ranking

Project	NPV	Ranking based on NPV	Manhours need	$$/ manhours	Cumulative manhours
Browser app	6,472,943	1	1875	3,452.24	1875
Portfolio tracking	1,199,640	5	750	1,599.52	2625
Expense report	598,520	6	400	1,496.30	3025
Calendar+email	1,623,200	4	1250	1,298.56	4275
Spreadsheet app	2,422,729	3	2500	969.09	6775
Trip planner app	2,895,464	2	6250	463.27	13025

Based on current manhours contraint (10,000 hours in the first year), all projects except trip planner app. This way it can maximize the return on manhour and the total NPV. If we choose only the highest NPV projects, the maximum NPV achieved is from Browser app and trip planner app which is $9.368M. On the other hand, if we choose projects based on NPV per manhour, we can choose all projects except trip planner app (5 in total) which have a combined NVP of $12.317M

Project	NPV	Leadership position	Web use
Browser app	6,472,943	moderately likely	moderate
Trip planner app	2,895,464	certain	little
Spreadsheet app	2,422,729	very likely	moderate
Calendar+email	1,623,200	moderately likely	no
Portfolio tracking	1,199,640	very unlikely	very high
Expense report	598,520	very unlikely	very high

Pointing system
NPV
Highest	6
Lowest	1
Leadership probability
very unlikely	1
moderately likely	2
very likely	3
certain	4
Web use
no	1
little	2
moderate	3
very high	4

Project	NPV points	Leadership points	Web use points	Weighted score	Factor scoring rank
Browser app	6	2	3	17	1
Trip planner app	5	4	2	16	2
Spreadsheet app	4	3	3	14	3
Calendar+email	3	2	1	9	4
Portfolio tracking	2	1	4	9	4
Expense report	1	1	4	7	5

=2*NPV points+ 1*Leadership points+ 1*Web use points

The ranking has not changed based on factor weighted method since NPV has the highest weight in this method.
If Handstar has to pursue only 1 project, it could go with the first project with highest NPV- Browser app. However, since the NPV of each project is +ve, it could ideally pursue all projects, in the order of ranking
Please note that the factor weightage ranking could change based on the scale used to allot points. In this sense, it is very subjective

Based on current NPV per manhour projection, if we hire 1 additional, we will still not have enough capacity to undertake all projects. We will 2 additional engineers which will cost $260,000 (=2500*52*2) per year. The cost over 3 years is $780,000. The NPV of project is $2.895M which is much more than the employee cost. Hence, it is justified to hire 2 additional software engineers, but not 1.