Licensing Strategies of the New "intellectual Property Vendors" 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 Licensing Strategies of the New "intellectual Property Vendors" case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Licensing Strategies of the New "intellectual Property Vendors" case study is a Harvard Business School (HBR) case study written by Lee Davis. The Licensing Strategies of the New "intellectual Property Vendors" (referred as “Licensing Ip” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Intellectual property.

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

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Case Description of Licensing Strategies of the New "intellectual Property Vendors" Case Study

This article explores the licensing strategies pursued by firms whose business model is based on developing and licensing out their intellectual property. These "intellectual property (IP) vendors" are not traditional suppliers, since they do not engage in production or commercialization, but specialize solely in the generation of IP. Considerable anecdotal evidence exists about these creative and enterprising firms. However, there has been no systematic investigation of how they use licensing to capture value from their IP. Our research indicates that their licensing strategies can be differentiated along two main dimensions. The first concerns the nature of the contractual relationship: whether the license stands alone or whether it is part of a larger package including other R&D collaborative agreements. The second concerns whether the technologies concerned are of high or low cumulativeness. These dimensions yield a typology outlining four different strategies IP vendors can use.

Case Authors : Lee Davis

Topic : Organizational Development

Related Areas : Intellectual property

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Calculating Net Present Value (NPV) at 6% for Licensing Strategies of the New "intellectual Property Vendors" Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10020833)	-10020833	-	-
Year 1	3462426	-6558407	3462426	0.9434	3266440
Year 2	3959374	-2599033	7421800	0.89	3523829
Year 3	3946696	1347663	11368496	0.8396	3313722
Year 4	3236352	4584015	14604848	0.7921	2563494
TOTAL			14604848		12667484

The Net Present Value at 6% discount rate is 2646651

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.

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Capital Budgeting Approaches

Methods of Capital Budgeting

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

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

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

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Formula and Steps to Calculate Net Present Value (NPV) of Licensing Strategies of the New "intellectual Property Vendors"

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 Licensing Ip 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 Licensing Ip 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 %	Discounted Cash Flows
Year 0	(10020833)	-10020833	-	-
Year 1	3462426	-6558407	3462426	0.8696	3010805
Year 2	3959374	-2599033	7421800	0.7561	2993856
Year 3	3946696	1347663	11368496	0.6575	2595017
Year 4	3236352	4584015	14604848	0.5718	1850395
TOTAL					10450072

The Net NPV after 4 years is 429239

(10450072 - 10020833 )

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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 %	Discounted Cash Flows
Year 0	(10020833)	-10020833	-	-
Year 1	3462426	-6558407	3462426	0.8333	2885355
Year 2	3959374	-2599033	7421800	0.6944	2749565
Year 3	3946696	1347663	11368496	0.5787	2283968
Year 4	3236352	4584015	14604848	0.4823	1560741
TOTAL					9479629

The Net NPV after 4 years is -541204

At 20% discount rate the NPV is negative (9479629 - 10020833 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Licensing Ip 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 Licensing Ip has a NPV value higher than Zero then finance managers at Licensing Ip 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 Licensing Ip, then the stock price of the Licensing Ip 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 Licensing Ip 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 key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What can impact the cash flow of the project.

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

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.

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.

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Negotiation Strategy of Licensing Strategies of the New "intellectual Property Vendors"

References & Further Readings

Lee Davis (2018), "Licensing Strategies of the New "intellectual Property Vendors" Harvard Business Review Case Study. Published by HBR Publications.