The Case of Synthroid (A), Spanish Version 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 The Case of Synthroid (A), Spanish Version case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Case of Synthroid (A), Spanish Version case study is a Harvard Business School (HBR) case study written by Alice M. Tybout, Julie Hennessy, Natalie Fahey, Charlotte Snyder. The The Case of Synthroid (A), Spanish Version (referred as “Synthroid Hypothyroidism” 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

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Case Description of The Case of Synthroid (A), Spanish Version Case Study

The case tells the story of Synthroid from its development in 1958 as the first synthetic thyroxine molecule to its competition against generic equivalents in 2004. The case introduces students to the pharmaceutical industry, its practices, and some of the complexities of pricing and drug choice, with drug manufacturers, insurance companies, physicians, pharmacists, and patients all playing a role. It also provides a primer on hypothyroidism, its symptoms, and its treatment. Because Synthroid was developed and introduced before FDA regulations and drug standards of identity were fully established, it was difficult for competitors to get their drugs certified as identical to Synthroid. Through a series of efforts with physicians, especially endocrinologists, Synthroid's owners were able to maintain the perception for forty-six years that Synthroid was uniquely effective. In 2004, however, the FDA declared several competitive products to be bioequivalent to Synthroid, which posed a significant challenge to its owner, Abbott Laboratories. Students are challenged to consider options to maintain the drug's unit volume, revenue, and/or profit in these difficult circumstances. The case is written in two parts. The (A) case provides background on the history of the drug, the pharmaceutical industry and its marketing practices, and hypothyroidism and its treatment, and it concludes in 2004 as Abbott's marketers face the impending challenge of defending the Synthroid business against generic competition. The (B) case describes what Abbott actually did to maintain its share in the United States and outlines its strategy in India, a market without patent protection for pharmaceuticals.

Case Authors : Alice M. Tybout, Julie Hennessy, Natalie Fahey, Charlotte Snyder

Topic : Sales & Marketing

Related Areas : Pricing

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Calculating Net Present Value (NPV) at 6% for The Case of Synthroid (A), Spanish Version Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018918)	-10018918	-	-
Year 1	3453021	-6565897	3453021	0.9434	3257567
Year 2	3965474	-2600423	7418495	0.89	3529258
Year 3	3965178	1364755	11383673	0.8396	3329240
Year 4	3237403	4602158	14621076	0.7921	2564326
TOTAL			14621076		12680391

The Net Present Value at 6% discount rate is 2661473

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

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Formula and Steps to Calculate Net Present Value (NPV) of The Case of Synthroid (A), Spanish Version

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 Synthroid Hypothyroidism 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 Synthroid Hypothyroidism 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	(10018918)	-10018918	-	-
Year 1	3453021	-6565897	3453021	0.8696	3002627
Year 2	3965474	-2600423	7418495	0.7561	2998468
Year 3	3965178	1364755	11383673	0.6575	2607169
Year 4	3237403	4602158	14621076	0.5718	1850996
TOTAL					10459260

The Net NPV after 4 years is 440342

(10459260 - 10018918 )

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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	(10018918)	-10018918	-	-
Year 1	3453021	-6565897	3453021	0.8333	2877518
Year 2	3965474	-2600423	7418495	0.6944	2753801
Year 3	3965178	1364755	11383673	0.5787	2294663
Year 4	3237403	4602158	14621076	0.4823	1561248
TOTAL					9487230

The Net NPV after 4 years is -531688

At 20% discount rate the NPV is negative (9487230 - 10018918 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Synthroid Hypothyroidism 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 Synthroid Hypothyroidism has a NPV value higher than Zero then finance managers at Synthroid Hypothyroidism 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 Synthroid Hypothyroidism, then the stock price of the Synthroid Hypothyroidism 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 Synthroid Hypothyroidism 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 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.

Understanding of risks involved in the project.

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

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 The Case of Synthroid (A), Spanish Version

References & Further Readings

Alice M. Tybout, Julie Hennessy, Natalie Fahey, Charlotte Snyder (2018), "The Case of Synthroid (A), Spanish Version Harvard Business Review Case Study. Published by HBR Publications.