Toyota's Strategy and Initiatives in Europe: The Launch of the Aygo 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 Toyota's Strategy and Initiatives in Europe: The Launch of the Aygo case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Toyota's Strategy and Initiatives in Europe: The Launch of the Aygo case study is a Harvard Business School (HBR) case study written by Kazuo Ichijo, George Radler. The Toyota's Strategy and Initiatives in Europe: The Launch of the Aygo (referred as “Toyota Toyota's” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Joint ventures.

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 Toyota's Strategy and Initiatives in Europe: The Launch of the Aygo Case Study

Toyota is one the most successful car companies in the world. The company set the ambitious growth goal of a 15% share of the global markets by 2010 (up from 11% in 2005). For this, the European market is becoming of strategic importance. The case outlines Toyota's global strategy before focusing on the European market in particular. Sales in Europe increased by over 50% between 2000 and 2005. In the process, Toyota's European manufacturing capacities more than tripled to over 600,000 units over the same period. Although Toyota was on the growth path, the launch of the Aygo posed many challenges. The segment was very price-sensitive and production cost had to be tightly controlled. Toyota decided to enter a joint venture with PSA, the maker of Peugeot/ CitroA?n. The case shows how cost reduction was the overriding principle and explains how both companies worked together. But selling a car with 93% parts commonality also posed many challenges on the marketing side: Toyota wanted to target younger customers in order to lower the average age of customers. Toyota had no experience in this segment and hence had to go new ways. The case takes readers through the various steps Toyota took in order to promote the Aygo. Learning objectives: Toyota is a latecomer to the European minicar segment. The case analyzes how Toyota changed the business system in order to deal with the various intricacies of this segment. On the manufacturing side, Toyota entered a joint venture with Peugeot/CitroA?n and built a new plant in the Czech Republic. The cars rolling off this assembly line had a parts commonality of 93%. But the innovations did not stop at the factory gate. Toyota invested in a massive Internet presence, meeting potential customers at locations of their preference and sponsorship of concerts etc. The case is a good platform for discussing Toyota's changes to the existing business system, both upstream and downstream.

Case Authors : Kazuo Ichijo, George Radler

Topic : Organizational Development

Related Areas : Joint ventures

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Calculating Net Present Value (NPV) at 6% for Toyota's Strategy and Initiatives in Europe: The Launch of the Aygo Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10007179)	-10007179	-	-
Year 1	3455387	-6551792	3455387	0.9434	3259799
Year 2	3977225	-2574567	7432612	0.89	3539716
Year 3	3958660	1384093	11391272	0.8396	3323767
Year 4	3225940	4610033	14617212	0.7921	2555247
TOTAL			14617212		12678529

The Net Present Value at 6% discount rate is 2671350

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. Toyota Toyota's 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 Toyota Toyota's 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 Toyota's Strategy and Initiatives in Europe: The Launch of the Aygo

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 Toyota Toyota's 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 Toyota Toyota's 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	(10007179)	-10007179	-	-
Year 1	3455387	-6551792	3455387	0.8696	3004684
Year 2	3977225	-2574567	7432612	0.7561	3007353
Year 3	3958660	1384093	11391272	0.6575	2602883
Year 4	3225940	4610033	14617212	0.5718	1844442
TOTAL					10459363

The Net NPV after 4 years is 452184

(10459363 - 10007179 )

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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	(10007179)	-10007179	-	-
Year 1	3455387	-6551792	3455387	0.8333	2879489
Year 2	3977225	-2574567	7432612	0.6944	2761962
Year 3	3958660	1384093	11391272	0.5787	2290891
Year 4	3225940	4610033	14617212	0.4823	1555720
TOTAL					9488062

The Net NPV after 4 years is -519117

At 20% discount rate the NPV is negative (9488062 - 10007179 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Toyota Toyota's 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 Toyota Toyota's has a NPV value higher than Zero then finance managers at Toyota Toyota's 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 Toyota Toyota's, then the stock price of the Toyota Toyota's 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 Toyota Toyota's 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 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.

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

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 Toyota's Strategy and Initiatives in Europe: The Launch of the Aygo

References & Further Readings

Kazuo Ichijo, George Radler (2018), "Toyota's Strategy and Initiatives in Europe: The Launch of the Aygo Harvard Business Review Case Study. Published by HBR Publications.