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PostPosted: Thu Oct 30, 2008 2:58 am 

Joined: Jun 27, 2008
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Managing Your Business, Lesson 7ish:
All is Well - Advantage Mine or Raw Deal?

"Never leave till tomorrow what you can do today."
-- Benjamin Franklin, Poor Richard's Almanac

"There is never enough time to do everything, but there is always enough time to do the most important thing."
-- Brian Tracy, The Law of Forced Efficiency

"I'm never funny."
-- Jean-Claude Van Damme, Timecop


I call this lesson "7ish" for now because I'm not sure where it will ultimately fit in the series, but it's more complicated. You really should have read Lesson 3 because this all stems from ROI. In fact, you should be familiar with the terms "Time Value of Money" and "Discount Rate" as described in the 3rd part of that lesson.

Why are you talking about time but making bad puns about Raw Materials?

First of all, technically it's wordplay, not puns. Shame on you.

Traditionally when I talk about buildings, I don't bring time into it. After all, a factory today is a factory tomorrow, and although the market might change, the mere passage of time doesn't force it to.

However, Raw Materials do change. They deplete down to zero, forcing you to buy something else or sell the land and replace it. It seems two questions arise about this:

1) Why am I buying land that will run out? Aren't I wasting my money?

And for people who get past that:

2) Why would I ever expand? The land still runs out, and I don't even get more supply from my expansion. Aren't I wasting my money?

Well I would like to answer these questions. And for those of you thinking "it's about time!" . . . You're right.

The Value of Time
This is why Lesson 3 brought up the term "Discount Rate." Discount Rate is how much your money's time is worth.

When we brought up Return on Investment (ROI) we covered the simple case where you could spend β 100,000 and receive β 6,000 and we say that's 6%. Then we said that ROI basically does the same thing with building costs and profits.

Well let's calculate it for a raw site. I'll pick Wood for being a basic item everyone needs. It comes from Timber Land.

Timber Land produces 500 wood per day, with a maximum (like all sites) of 120 day supply. In Abalesk this costs β222,500. In Bellerive, it's β199,500. We'll say β210,000 to split the difference.

Code:
Timber Land, 500 Wood per day, 120 days: Total, β210,000


Wood sells from the NPC for about β53 with several people undercutting it in Bellerive, and β58 with no one else on the market in Abalesk. I'll be conservative and say you sell it for β50. Since there are no inputs, and no production cost, that β50 is all profit.

Therefore, we profit 50 * 500 = β25,000 per day on this land. And it costs us β210,00 to acquire a full property. Thus the ROI is gained by simply dividing.

ROI = 11.9%

That already looks pretty good. We should pick a slightly more conservative number, and we know other investments have their own limits. So let's say a nice number like 10% is what we expect our investment to be worth.

Discount Rate = 10%

The Question

You know your discount rate is 10%. I offer to pay you β1,000,000 in exactly 24 hours. How much is that offer worth right now?

_________________
The Guide to Managing your Simunomics Business:
Lesson 1: Should Bill Gates cut his own lawn?
Lesson 2: The Apple Forest or the Apple Tree?
Lesson 3: Which Business is Best?
Lesson 7: All is Well - Advantage Mine or Raw Deal?
Lesson 8: The Art of the Business of War


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PostPosted: Thu Oct 30, 2008 2:58 am 

Joined: Jun 27, 2008
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The Answer

Well obviously it should be less. This is why it's called a "discount rate." It tells us how much cheaper a future payment is in value. Let's work backwards to find out why.

Suppose you were given β 909,091 right now. You could use that to buy more buildings. And we know that buildings give us a Return on Investment of 10%. In 24 hours we would earn 10% of that amount, or β90,909.

909,091 + 90,909 = 1,000,000

So that's the answer. The amount we could get today, plus one day's return, equals the amount we could get tomorrow.

And to get that, I just divided interest instead of multiplying it.

100% (basic amount) + 10% (ROI) = 110% = 1.1

β1,000,000 / 1.1 = β909,091

And it's just that simple. Now we know not just that money is less tomorrow, but how much less it is worth. 1 million tomorrow is worth 909k today.

Even Further in the Future

Based on that, how much is a million βucks worth in 2 days?

β1,000,000 / 1.1 / 1.1 = β826,446

And so on for as far in the future as you like. If you were getting paid every day, you could just take the earnings each day in the future, use the discount rate to find out what it's worth today, and add them up. This is called a "Discounted Cash Flow"

Example: β1 million a day for 5 days (starting today) is worth how much right now? (Hint, not 5 million)
Code:
Day #   Payment then   Value Today
------+--------------+------------
Day 0:   1,000,000     909,091
Day 1:   1,000,000     826,446
Day 2:   1,000,000     751,315
Day 3:   1,000,000     683,013
Day 4:   1,000,000     620,921
                       ----------
   Total Value Today 3,790,786


That sum is often known as Present Value, which means simply "what it's all worth right now."

Back to Raw Materials
As you might have guessed, we can do exactly this with our Timber Land. Because it's 120 days, I'm going to do it in an Excel spreadsheet rather than fill up this page with numbers. But it is done exactly in the style of that last example, with the number we found earlier of β25,000 per day.

Code:
Day #   Payment then   Value Today
------+--------------+------------
Day 1:   25,000     22,727.27
Day 2:   25,000     20,661.15
...
Day 120: 25,000          0.27

That's no typo. Receiving that money 4 months out is so unimportant today it's worth pennies. That's why interest is so powerful.

The sum, or Present Value, of all 120 days is β249,997 (If anyone is curious by the way, had we gone on earning forever it would have added up to a perfect β250,000.)

But then I have to buy a new one!
True. But if money in has to get discounted, then money out can get discounted too.

Day 120: -210,000
Discounted: -210,000 / (1.1 ^ 120)
Value today = β2.27

That's right, 2 bucks. You spend just 2 bucks now, and earn 10% a day, by the time your Raw Materials Site runs out you will have all you need for a new one. And you're spending a lot more than β2.27 now, so that replacement will be like nothing.

Value of the Deal
To be complete in our analysis, we should consider what we pay now and subtract that from the sum.

Cost to buy = β210,000
Present Value of Earnings = β249,997

Value of the Deal = β249,997 - 210,000 = β39,997

If that doesn't seem like a lot, remember that you have already earned a full return on your money. That's not β40k on your investment. That's 40k in your pocket right now because you were smart enough to make this deal. You make millions on your investment, and discounting factored it out.

Even if the value of a deal is zero, it's still a good place for your money because you earn the full ROI. Only a negative number is a bad thing. (For example, investing β300k for a Present Value of β250k would not be smart.)

And if we expand?

To calculate it expanded is the same thing. Now the cost is twice as much, the earnings per day are twice as much, and the time is half (60 days). This time I will include the investment:

Code:
Day #   Payment then   Value Today
------+--------------+------------
Day 0:   -210,000   -210,000.00 (Initial purchase)
Day 0:   -160,000   -160,000.00 (Full Expansion)
Day 1:     50,000     45,454.55
Day 2:     50,000     41,322.31
...
Day 60:    50,000        164.21
-----------------------------------
Value of the Deal =  128,357.90


Not only is it still positive, it's bigger! Even though your investment seems to "run out" faster, getting that money faster is worth more than what you spend.

And expanding twice gives Value = β128,357.90 even though you run out in 40 days.

Conclusion
We get spoiled with the idea that you buy a building once and it lasts forever. And it may seem surprising that profit is good on something that runs out. But you also know that your company 4 months from now will be huge compared to its size today. Even one month out you're big enough not to worry about it. And that's basically why a replacement cost in the future should not talk you out of a good deal today.

Not only can buying a Raw Materials land be profitable, but expanding it is even better.


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PostPosted: Thu Oct 30, 2008 3:05 am 

Joined: Jun 27, 2008
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Other considerations
As is always true with an economy, there are other factors to consider.

Maybe there is a lot of supply and not much demand for your product. That would mean lower prices, or maybe you can't even find buyers at all! As always, the market rules these things. This analysis assumes you can get a reasonable price and sell everything you extract.

On the other hand, maybe limited supply scares people away from building these (because they didn't bother reading this like you did - bravo for you!). If that's true, you can get a higher price and that just blows all of this away. Then it's definitely worth expanding - at least until you have so much supply it warps the market.

And another consideration is our ROI. I think 10% is at least fair from what I've seen elsewhere in the game. But if an opportunity comes up for you to make 12% on some other investment, then you should re-evaluate everything we said - at which point a Raw Materials spot probably wouldn't be worth it even if it lasted forever.

This guide is subject to change at some point, and the "7ish" should have been a hint. :smile:

_________________
The Guide to Managing your Simunomics Business:
Lesson 1: Should Bill Gates cut his own lawn?
Lesson 2: The Apple Forest or the Apple Tree?
Lesson 3: Which Business is Best?
Lesson 7: All is Well - Advantage Mine or Raw Deal?
Lesson 8: The Art of the Business of War


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PostPosted: Thu Oct 30, 2008 12:07 pm 

Joined: Jun 26, 2008
Posts: 213
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First of all, first place :lol:

Ok back to topic.

I have read through these wall of text and I am impressed. The concept of discount rate is really good. Also I have got some enlightenment.

Anyway, good guide as usual

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Spokesman of ReadOnly, the dominant company offerring education material to all ages

My guides(update)
Basic Tips & Land Choice
Megastore


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PostPosted: Fri Oct 31, 2008 1:54 am 

Joined: Jun 27, 2008
Posts: 313
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"Wall of text"!?!? :grrr:

The phrase "wall of text" generally refers to endless talking with no formatting, no paragraph breaks, and hardly a breath. Admittedly I have no pretty pictures, but I think I did a pretty good job breaking it up with formatting.

However I wasn't as jovial this time as I usually am, partly because it's my first draft and partly because this is by far the toughest topic I've covered so far.


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PostPosted: Fri Oct 31, 2008 4:12 pm 

Joined: Jun 26, 2008
Posts: 213
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Knolls wrote:
"Wall of text"!?!? :grrr:

The phrase "wall of text" generally refers to endless talking with no formatting, no paragraph breaks, and hardly a breath. Admittedly I have no pretty pictures, but I think I did a pretty good job breaking it up with formatting.

However I wasn't as jovial this time as I usually am, partly because it's my first draft and partly because this is by far the toughest topic I've covered so far.


Oh, maybe I misunderstood the meaning.

I thought 'wall of text' means a lot of text :P Sorry for my poor English...

_________________
Spokesman of ReadOnly, the dominant company offerring education material to all ages

My guides(update)
Basic Tips & Land Choice
Megastore


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PostPosted: Mon Nov 03, 2008 12:31 pm 
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User avatarAllmart
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Great guide btw Knolls.

Hint: You might get a kick out of analyzing the prices charged for building a mine in the first place.


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PostPosted: Mon Nov 03, 2008 11:05 pm 

Joined: Jun 27, 2008
Posts: 313
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I had a feeling when I saw how it diminished, and considered reverse-engineering to get the discount rate. But haven't done so yet.

_________________
The Guide to Managing your Simunomics Business:
Lesson 1: Should Bill Gates cut his own lawn?
Lesson 2: The Apple Forest or the Apple Tree?
Lesson 3: Which Business is Best?
Lesson 7: All is Well - Advantage Mine or Raw Deal?
Lesson 8: The Art of the Business of War


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