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Sy.Med Development, Inc. 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 Sy.Med Development, Inc. case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Sy.Med Development, Inc. case study is a Harvard Business School (HBR) case study written by Randle D. Raggio. The Sy.Med Development, Inc. (referred as “Sy.med Pricing” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Pricing.

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 Sy.Med Development, Inc. Case Study


In March of 2001, the president of Sy.Med Development, Inc. (Sy.Med), a small health-care software firm, was concerned about his company's sales performance in the year-to-date. Nine units were projected, but only three had been sold. As a result, Sy.Med was 66 per cent below the president's unit forecast, 210 per cent below his net income forecast, and had lost $40,000. The president wondered whether a change to the base price of the software was necessary to boost sales. The case introduces the concept of "value pricing," that is, pricing on the basis of value received by customers, not pricing on the basis of the cost of providing the product or service. The concept of value pricing at Sy.Med requires the simultaneous consideration of customer segments and sales force allocation in a high-tech setting. With careful calculation, students can determine the benefit to a particular customer of using the OneApp software. Some sensitivity analysis is required because not all practice sizes are equivalent, nor do they face the same labor costs. Although the pricing decision is the focus of the case, strategy (e.g. relating to customer selection, strategic focus) and sales force issues are inextricably linked to this decision. After the class discussion is complete, students should understand that pricing decisions cannot be made in isolation; the strategy and structure of the market must be considered. The case works well in the core MBA marketing course to introduce the concept of value pricing, and equally well in a course focused on pricing to emphasize the interrelations among organizational issues, the competitive market and the pricing decision. The case can also be used in an orientation program or as an introductory case to help train students in the art of preparing a quantitative case analysis.


Case Authors : Randle D. Raggio

Topic : Sales & Marketing

Related Areas : Pricing




Calculating Net Present Value (NPV) at 6% for Sy.Med Development, Inc. Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10011287) -10011287 - -
Year 1 3455653 -6555634 3455653 0.9434 3260050
Year 2 3968060 -2587574 7423713 0.89 3531559
Year 3 3966369 1378795 11390082 0.8396 3330240
Year 4 3229589 4608384 14619671 0.7921 2558137
TOTAL 14619671 12679986


The Net Present Value at 6% discount rate is 2668699

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

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 Sy.med Pricing 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. Sy.med Pricing 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 Sy.Med Development, Inc.

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 Sales & Marketing 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 Sy.med Pricing 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 Sy.med Pricing 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 (10011287) -10011287 - -
Year 1 3455653 -6555634 3455653 0.8696 3004916
Year 2 3968060 -2587574 7423713 0.7561 3000423
Year 3 3966369 1378795 11390082 0.6575 2607952
Year 4 3229589 4608384 14619671 0.5718 1846528
TOTAL 10459819


The Net NPV after 4 years is 448532

(10459819 - 10011287 )






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 (10011287) -10011287 - -
Year 1 3455653 -6555634 3455653 0.8333 2879711
Year 2 3968060 -2587574 7423713 0.6944 2755597
Year 3 3966369 1378795 11390082 0.5787 2295352
Year 4 3229589 4608384 14619671 0.4823 1557479
TOTAL 9488140


The Net NPV after 4 years is -523147

At 20% discount rate the NPV is negative (9488140 - 10011287 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Sy.med Pricing 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 Sy.med Pricing has a NPV value higher than Zero then finance managers at Sy.med Pricing 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 Sy.med Pricing, then the stock price of the Sy.med Pricing 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 Sy.med Pricing 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 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.

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.

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

Randle D. Raggio (2018), "Sy.Med Development, Inc. Harvard Business Review Case Study. Published by HBR Publications.