Converting the North American Decking Market 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 Converting the North American Decking Market case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Converting the North American Decking Market case study is a Harvard Business School (HBR) case study written by Wolfgang Ulaga, Katrin Siebenburger, Victoria Kemanian. The Converting the North American Decking Market (referred as “Decking Hilti” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Innovation, Marketing, Organizational culture, Sales, Social platforms.

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 Converting the North American Decking Market Case Study

Problem: Hilti had targeted its "direct fastening" technology - using propellants to drive nails into concrete or steel - at the large and attractive North American decking market where decking involved attaching profiled metal sheets for floors or roofs to a building's frame, mostly by welding. However, after several years, Hilti had still not succeeded in converting deck installers to its technology, and market share was in single digits. Solution: Decrease conversion barriers for all players in the value chain through a multi-dimensional approach consisting of offering product and service innovation, engineering support and new marketing tools that demonstrated the increased productivity, quality and worker safety compared to welding. Key steps: 1. Develop a customized product offering addressing country- and segment-specific requirements; 2. Launch a new service and transaction model to decrease upfront investment and switching costs; 3. Develop targeted sales and marketing initiatives to gain support from the complex network of stakeholders in the value chain. Learning objective: Understand what successful strategies can be employed to capture value from innovation in a B2B environment that represents many barriers to adoption for new technology; illustrate key steps taken by the company showcased to re-launch an innovative product in the B2B construction market that initially failed to capture market share.

Case Authors : Wolfgang Ulaga, Katrin Siebenburger, Victoria Kemanian

Topic : Sales & Marketing

Related Areas : Innovation, Marketing, Organizational culture, Sales, Social platforms

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Calculating Net Present Value (NPV) at 6% for Converting the North American Decking Market Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10001220)	-10001220	-	-
Year 1	3443295	-6557925	3443295	0.9434	3248392
Year 2	3963624	-2594301	7406919	0.89	3527611
Year 3	3963307	1369006	11370226	0.8396	3327669
Year 4	3230351	4599357	14600577	0.7921	2558741
TOTAL			14600577		12662412

The Net Present Value at 6% discount rate is 2661192

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. Payback Period
2. Internal Rate of Return
3. Profitability Index
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. Timing of the expected cash flows – stockholders of Decking Hilti 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. Decking Hilti 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 Converting the North American Decking Market

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 Decking Hilti 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 Decking Hilti 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	(10001220)	-10001220	-	-
Year 1	3443295	-6557925	3443295	0.8696	2994170
Year 2	3963624	-2594301	7406919	0.7561	2997069
Year 3	3963307	1369006	11370226	0.6575	2605939
Year 4	3230351	4599357	14600577	0.5718	1846964
TOTAL					10444141

The Net NPV after 4 years is 442921

(10444141 - 10001220 )

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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	(10001220)	-10001220	-	-
Year 1	3443295	-6557925	3443295	0.8333	2869413
Year 2	3963624	-2594301	7406919	0.6944	2752517
Year 3	3963307	1369006	11370226	0.5787	2293580
Year 4	3230351	4599357	14600577	0.4823	1557847
TOTAL					9473356

The Net NPV after 4 years is -527864

At 20% discount rate the NPV is negative (9473356 - 10001220 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Decking Hilti 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 Decking Hilti has a NPV value higher than Zero then finance managers at Decking Hilti 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 Decking Hilti, then the stock price of the Decking Hilti 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 Decking Hilti 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 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.

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

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 Converting the North American Decking Market

References & Further Readings

Wolfgang Ulaga, Katrin Siebenburger, Victoria Kemanian (2018), "Converting the North American Decking Market Harvard Business Review Case Study. Published by HBR Publications.