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Forus Health: Crossing the Disruptive Product Chasm 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 Forus Health: Crossing the Disruptive Product Chasm case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Forus Health: Crossing the Disruptive Product Chasm case study is a Harvard Business School (HBR) case study written by Ramesh Narasimhan, M.V. Ravikumar, Nattuvathuckal Barnabas. The Forus Health: Crossing the Disruptive Product Chasm (referred as “3nethra Forus” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, 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






Case Description of Forus Health: Crossing the Disruptive Product Chasm Case Study


In April 2013, the co-founder and chief executive officer of Forus Health Private Limited sat in his office in Bangalore, India contemplating the future direction of his company. He was under pressure by his venture capital partner to rapidly penetrate the market for 3nethra - an innovative, multi-functional and low-cost ophthalmology device - before imitators stepped in. Given its features and advantages over expensive imported specialized tools, 3nethra could help address the huge challenge of preventable blindness in India, but after three years since inception, only 100 devices had been sold. Although the market opportunity was large, acceptance by the ophthalmology profession was key to gaining momentum. He had two choices: to maximize sales numbers through the scattergun tactic of going all out and all over the market or to build a sufficient base of positive word of mouth to gain the momentum necessary to pole-vault from the early to the mainstream market. How should he direct his sales team to take the company forward? Ramesh Narasimhan is affiliated with Narsee Monjee Institute of Management Studies (NMIMS). Nattuvathuckal Barnabas is affiliated with SVKM'S NMINMS University.


Case Authors : Ramesh Narasimhan, M.V. Ravikumar, Nattuvathuckal Barnabas

Topic : Sales & Marketing

Related Areas : Technology




Calculating Net Present Value (NPV) at 6% for Forus Health: Crossing the Disruptive Product Chasm Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10027052) -10027052 - -
Year 1 3447662 -6579390 3447662 0.9434 3252511
Year 2 3974069 -2605321 7421731 0.89 3536907
Year 3 3947148 1341827 11368879 0.8396 3314102
Year 4 3236104 4577931 14604983 0.7921 2563297
TOTAL 14604983 12666818




The Net Present Value at 6% discount rate is 2639766

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. 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 3nethra Forus 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. 3nethra Forus 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 Forus Health: Crossing the Disruptive Product Chasm

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 3nethra Forus 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 3nethra Forus 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 (10027052) -10027052 - -
Year 1 3447662 -6579390 3447662 0.8696 2997967
Year 2 3974069 -2605321 7421731 0.7561 3004967
Year 3 3947148 1341827 11368879 0.6575 2595314
Year 4 3236104 4577931 14604983 0.5718 1850253
TOTAL 10448501


The Net NPV after 4 years is 421449

(10448501 - 10027052 )








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 (10027052) -10027052 - -
Year 1 3447662 -6579390 3447662 0.8333 2873052
Year 2 3974069 -2605321 7421731 0.6944 2759770
Year 3 3947148 1341827 11368879 0.5787 2284229
Year 4 3236104 4577931 14604983 0.4823 1560621
TOTAL 9477672


The Net NPV after 4 years is -549380

At 20% discount rate the NPV is negative (9477672 - 10027052 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of 3nethra Forus 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 3nethra Forus has a NPV value higher than Zero then finance managers at 3nethra Forus 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 3nethra Forus, then the stock price of the 3nethra Forus 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 3nethra Forus 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 will be a multi year spillover effect of various taxation regulations.

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.

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 Forus Health: Crossing the Disruptive Product Chasm

References & Further Readings

Ramesh Narasimhan, M.V. Ravikumar, Nattuvathuckal Barnabas (2018), "Forus Health: Crossing the Disruptive Product Chasm Harvard Business Review Case Study. Published by HBR Publications.


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