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Xiameter: The Past and Future of a "Disruptive Innovation" 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 Xiameter: The Past and Future of a "Disruptive Innovation" case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Xiameter: The Past and Future of a "Disruptive Innovation" case study is a Harvard Business School (HBR) case study written by Kamran Kashani, Inna Francis. The Xiameter: The Past and Future of a "Disruptive Innovation" (referred as “Xiameter Bundling” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Competition.

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 Xiameter: The Past and Future of a "Disruptive Innovation" Case Study


The case study is about a successful strategy formulated at Dow Corning for marketing commodity silicones, a chemical used in diverse applications. It deals with important issues in B2B marketing: refocusing on user needs and developing a "needs-based" segmentation of industrial customers; bundling and de-bundling of technical services; branding of commodity chemicals; web-based low price/no-frills value proposition; making money with commodities. The case also describes a "tipping point" in Dow Corning's history and strategy where their leadership in the silicone business was at stake; management had to chart radically new ways to compete in commoditized markets--what they call their "disruptive innovation". At the end the students are asked to look at the success of Xiameter (the company's web-based brand) and decide its future. The choices are: maintain status quo; incrementally fine tune the strategy; go for a major overhaul. Learning objectives: The Xiameter case can be used to: 1) show an example of using customer insights in successfully re-defining business and marketing strategies; 2) address issues of segmentation, value proposition and branding in industrial marketing; 3) demonstrate how two contrasting value propositions could be offered to industrial customers under different brands; 4) discuss value innovation in B2B markets ; 5) examine and analyze elements of a successful web-based business model; 6) learn how adversity can challenge an organization to re-define its business and marketing strategies for future success.


Case Authors : Kamran Kashani, Inna Francis

Topic : Sales & Marketing

Related Areas : Competition




Calculating Net Present Value (NPV) at 6% for Xiameter: The Past and Future of a "Disruptive Innovation" Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10014078) -10014078 - -
Year 1 3461267 -6552811 3461267 0.9434 3265346
Year 2 3958053 -2594758 7419320 0.89 3522653
Year 3 3954926 1360168 11374246 0.8396 3320632
Year 4 3225636 4585804 14599882 0.7921 2555006
TOTAL 14599882 12663637




The Net Present Value at 6% discount rate is 2649559

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. Internal Rate of Return
2. Profitability Index
3. Payback Period
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Xiameter Bundling 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 Xiameter Bundling have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.






Formula and Steps to Calculate Net Present Value (NPV) of Xiameter: The Past and Future of a "Disruptive Innovation"

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 Xiameter Bundling 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 Xiameter Bundling 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 (10014078) -10014078 - -
Year 1 3461267 -6552811 3461267 0.8696 3009797
Year 2 3958053 -2594758 7419320 0.7561 2992857
Year 3 3954926 1360168 11374246 0.6575 2600428
Year 4 3225636 4585804 14599882 0.5718 1844268
TOTAL 10447350


The Net NPV after 4 years is 433272

(10447350 - 10014078 )








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 (10014078) -10014078 - -
Year 1 3461267 -6552811 3461267 0.8333 2884389
Year 2 3958053 -2594758 7419320 0.6944 2748648
Year 3 3954926 1360168 11374246 0.5787 2288730
Year 4 3225636 4585804 14599882 0.4823 1555573
TOTAL 9477340


The Net NPV after 4 years is -536738

At 20% discount rate the NPV is negative (9477340 - 10014078 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Xiameter Bundling 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 Xiameter Bundling has a NPV value higher than Zero then finance managers at Xiameter Bundling 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 Xiameter Bundling, then the stock price of the Xiameter Bundling 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 Xiameter Bundling 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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

What can impact the cash flow of the project.

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.






Negotiation Strategy of Xiameter: The Past and Future of a "Disruptive Innovation"

References & Further Readings

Kamran Kashani, Inna Francis (2018), "Xiameter: The Past and Future of a "Disruptive Innovation" Harvard Business Review Case Study. Published by HBR Publications.


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