Leveraging the Power of Intangible Assets Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Leveraging the Power of Intangible Assets case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Leveraging the Power of Intangible Assets case study is a Harvard Business School (HBR) case study written by Wlodek Zadrozny, Zadrozny Wlodek. The Leveraging the Power of Intangible Assets (referred as “Information Answer” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Competitive strategy, IT, Knowledge management.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

Case Description of Leveraging the Power of Intangible Assets Case Study

This is an MIT Sloan Management Review article. Many managers have anticipated the time when they could track information about their intangible assets as easily as they monitor cash flow and market share. They have looked forward to being able to track customer satisfaction, innovation, and employee skill levels with real-time data. Thanks to advances in information technology, this day is almost here. Yet, the author argues that few managers have begun even to scratch the surface in seizing the opportunities that this information offers. Managers will need to determine which parts of the business they want to understand; what information will lead to an answer; and how well the information and technology (including text and data mining) can answer their questions. Currently, companies extract information about intangibles for fairly narrow applications (for example, to analyze data about customer preferences to improve the profitability of certain customer segments). But managers looking to derive maximum value will want to use this information more robustly. They should consider a set of factors: the nature of the questions they want to answer; the quality of the data available; the technology they need to use; and the extent to which major process changes will impact the organization.

Case Authors : Wlodek Zadrozny, Zadrozny Wlodek

Topic : Organizational Development

Related Areas : Competitive strategy, IT, Knowledge management

Calculating Net Present Value (NPV) at 6% for Leveraging the Power of Intangible Assets Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10024753) -10024753 - -
Year 1 3447146 -6577607 3447146 0.9434 3252025
Year 2 3961820 -2615787 7408966 0.89 3526006
Year 3 3968437 1352650 11377403 0.8396 3331976
Year 4 3235306 4587956 14612709 0.7921 2562665
TOTAL 14612709 12672672

The Net Present Value at 6% discount rate is 2647919

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Payback Period
2. Profitability Index
3. Internal Rate of Return
4. Net Present Value

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Timing of the expected cash flows – stockholders of Information Answer have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Information Answer shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

Formula and Steps to Calculate Net Present Value (NPV) of Leveraging the Power of Intangible Assets

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Organizational Development Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Information Answer often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Information Answer needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 15 %
Cash Flows
Year 0 (10024753) -10024753 - -
Year 1 3447146 -6577607 3447146 0.8696 2997518
Year 2 3961820 -2615787 7408966 0.7561 2995705
Year 3 3968437 1352650 11377403 0.6575 2609312
Year 4 3235306 4587956 14612709 0.5718 1849797
TOTAL 10452332

The Net NPV after 4 years is 427579

(10452332 - 10024753 )

Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 20 %
Cash Flows
Year 0 (10024753) -10024753 - -
Year 1 3447146 -6577607 3447146 0.8333 2872622
Year 2 3961820 -2615787 7408966 0.6944 2751264
Year 3 3968437 1352650 11377403 0.5787 2296549
Year 4 3235306 4587956 14612709 0.4823 1560236
TOTAL 9480671

The Net NPV after 4 years is -544082

At 20% discount rate the NPV is negative (9480671 - 10024753 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Information Answer to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Information Answer has a NPV value higher than Zero then finance managers at Information Answer can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Information Answer, then the stock price of the Information Answer should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Information Answer should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

What can impact the cash flow of the project.

What will be a multi year spillover effect of various taxation regulations.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Understanding of risks involved in the project.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

References & Further Readings

Wlodek Zadrozny, Zadrozny Wlodek (2018), "Leveraging the Power of Intangible Assets Harvard Business Review Case Study. Published by HBR Publications.