Siemens: Building a Structure to Drive Performance and Responsibility (A) 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 Siemens: Building a Structure to Drive Performance and Responsibility (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Siemens: Building a Structure to Drive Performance and Responsibility (A) case study is a Harvard Business School (HBR) case study written by Jesper Sorensen, Sara Gaviser Leslie. The Siemens: Building a Structure to Drive Performance and Responsibility (A) (referred as “Scher La” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Decision making, International business, Leadership, Leadership development, Organizational culture, Organizational structure, Sales, Technology.

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 Siemens: Building a Structure to Drive Performance and Responsibility (A) Case Study

Peter LA?scher became CEO of Siemens in July, 2007. It was one of the most turbulent times in the company's history as the company was reeling from a compliance scandal involving hundreds of millions of Euros in suspected bribes, and had to pay billions of Euros in fines and fees to clear its name. Further, the company's operating groups were underperforming their peers in terms of profitability, and had been for some time. Adding to the challenges, LA?scher was the first outsider to run Siemens since the company's founding in 1847. After his arrival, LA?scher moved quickly to assess the organization, a global, multi-line technology and engineering firm with over 475,000 employees and over a??66,487 million of revenue and a??3,345 million of net income. Klaus Kleinfeld, the previous CEO, had improved company performance, driven the company to become more globally focused, and sold off underperforming and non-core assets. However, his tenure was cut short by the bribery scandal. When LA?scher arrived, he felt the company was overly complex, individuals lacked accountability and significant tension existed between headquarters and the regions. LA?scher took advantage of the crisis to reorganize the company from 10 operating groups to 3 sectors, introduce regional clusters to enable smaller markets to focus on sales, establish the "right of way" of the global business, simplify financial reporting, and enhance the sales effort to market verticals. In addition to the changes that LA?scher made to the company structure, he transformed employees' attitudes and renewed the entrepreneurial and innovative spirit among managers in the organization.

Case Authors : Jesper Sorensen, Sara Gaviser Leslie

Topic : Organizational Development

Related Areas : Decision making, International business, Leadership, Leadership development, Organizational culture, Organizational structure, Sales, Technology

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Calculating Net Present Value (NPV) at 6% for Siemens: Building a Structure to Drive Performance and Responsibility (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019538)	-10019538	-	-
Year 1	3445144	-6574394	3445144	0.9434	3250136
Year 2	3966611	-2607783	7411755	0.89	3530270
Year 3	3973375	1365592	11385130	0.8396	3336122
Year 4	3236330	4601922	14621460	0.7921	2563476
TOTAL			14621460		12680004

The Net Present Value at 6% discount rate is 2660466

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. Internal Rate of Return
3. Net Present Value
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. Timing of the expected cash flows – stockholders of Scher La 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. Scher La shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Siemens: Building a Structure to Drive Performance and Responsibility (A)

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 Scher La 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 Scher La 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	(10019538)	-10019538	-	-
Year 1	3445144	-6574394	3445144	0.8696	2995777
Year 2	3966611	-2607783	7411755	0.7561	2999328
Year 3	3973375	1365592	11385130	0.6575	2612559
Year 4	3236330	4601922	14621460	0.5718	1850382
TOTAL					10458046

The Net NPV after 4 years is 438508

(10458046 - 10019538 )

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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	(10019538)	-10019538	-	-
Year 1	3445144	-6574394	3445144	0.8333	2870953
Year 2	3966611	-2607783	7411755	0.6944	2754591
Year 3	3973375	1365592	11385130	0.5787	2299407
Year 4	3236330	4601922	14621460	0.4823	1560730
TOTAL					9485681

The Net NPV after 4 years is -533857

At 20% discount rate the NPV is negative (9485681 - 10019538 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Scher La 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 Scher La has a NPV value higher than Zero then finance managers at Scher La 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 Scher La, then the stock price of the Scher La 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 Scher La 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 –

Understanding of risks involved in 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.

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.

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 Siemens: Building a Structure to Drive Performance and Responsibility (A)

References & Further Readings

Jesper Sorensen, Sara Gaviser Leslie (2018), "Siemens: Building a Structure to Drive Performance and Responsibility (A) Harvard Business Review Case Study. Published by HBR Publications.