Xbox Launch in Korea 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 Xbox Launch in Korea case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Xbox Launch in Korea case study is a Harvard Business School (HBR) case study written by Michaela Draganska, Frederic Descamps, Christopher Pennya. The Xbox Launch in Korea (referred as “Xbox Console” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, .

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 Xbox Launch in Korea Case Study

In August 2002, Microsoft approached the one-year anniversary of its video game console, the Xbox. The first wave of console systems were available in the United States, Japan, Europe, and Australia, and the second wave of rollouts was targeted for Asian markets: Korea, Taiwan, Hong Kong, and Singapore. Dan Adelman, business development manager for the Xbox, and Brenda Ng, Xbox's consumer strategy and research manager, considered the marketing data for the Korea launch. They needed to analyze the findings of the first report and to identify issues to resolve in a second, follow-up marketing study. Over the course of the next few months, Adelman and Ng would direct the Xbox team in identifying console purchase drivers and deciding what segments of gamers to target and the message to send to the target segments.

Case Authors : Michaela Draganska, Frederic Descamps, Christopher Pennya

Topic : Sales & Marketing

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Xbox Launch in Korea Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10024404)	-10024404	-	-
Year 1	3470116	-6554288	3470116	0.9434	3273694
Year 2	3974768	-2579520	7444884	0.89	3537529
Year 3	3943969	1364449	11388853	0.8396	3311432
Year 4	3229192	4593641	14618045	0.7921	2557823
TOTAL			14618045		12680479

The Net Present Value at 6% discount rate is 2656075

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 Xbox Console 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. Xbox Console 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 Xbox Launch in Korea

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 Xbox Console 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 Xbox Console 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	(10024404)	-10024404	-	-
Year 1	3470116	-6554288	3470116	0.8696	3017492
Year 2	3974768	-2579520	7444884	0.7561	3005496
Year 3	3943969	1364449	11388853	0.6575	2593224
Year 4	3229192	4593641	14618045	0.5718	1846301
TOTAL					10462512

The Net NPV after 4 years is 438108

(10462512 - 10024404 )

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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	(10024404)	-10024404	-	-
Year 1	3470116	-6554288	3470116	0.8333	2891763
Year 2	3974768	-2579520	7444884	0.6944	2760256
Year 3	3943969	1364449	11388853	0.5787	2282389
Year 4	3229192	4593641	14618045	0.4823	1557288
TOTAL					9491696

The Net NPV after 4 years is -532708

At 20% discount rate the NPV is negative (9491696 - 10024404 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Xbox Console 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 Xbox Console has a NPV value higher than Zero then finance managers at Xbox Console 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 Xbox Console, then the stock price of the Xbox Console 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 Xbox Console 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 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.

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 Xbox Launch in Korea

References & Further Readings

Michaela Draganska, Frederic Descamps, Christopher Pennya (2018), "Xbox Launch in Korea Harvard Business Review Case Study. Published by HBR Publications.