Hewlett-Packard--Computer Systems Organization: Selling to Enterprise Customers 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 Hewlett-Packard--Computer Systems Organization: Selling to Enterprise Customers case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Hewlett-Packard--Computer Systems Organization: Selling to Enterprise Customers case study is a Harvard Business School (HBR) case study written by Das Narayandas, Robert C. Dudley. The Hewlett-Packard--Computer Systems Organization: Selling to Enterprise Customers (referred as “Hp's Hp” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, IT, Sales.

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 Hewlett-Packard--Computer Systems Organization: Selling to Enterprise Customers Case Study

In late 1996, Manuel Diaz, head of Worldwide Sales for Hewlett-Packard's (HP) Computer Systems Organization (CSO), is reviewing the results of an audit of HP's enterprise customer management approach with the objective of identifying market and organizational opportunities that might provide HP the next wave of growth while further reducing sales and support costs. HP's current customer management approach, although successful, had involved structural changes that had forced a deep-rooted overhaul of HP's traditional regional sales approach. The new recommendations would necessitate another round of drastic changes in the way HP manages relationships with its large enterprise customers. Diaz does not want to put the sales organization through another round of changes unless he is sure they are necessary. He has to figure out if the organization is ready for more change, and whether the benefits outweigh the costs of implementation. The case provides a detailed review of the audit process and the findings.

Case Authors : Das Narayandas, Robert C. Dudley

Topic : Sales & Marketing

Related Areas : IT, Sales

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Calculating Net Present Value (NPV) at 6% for Hewlett-Packard--Computer Systems Organization: Selling to Enterprise Customers Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10027741)	-10027741	-	-
Year 1	3465833	-6561908	3465833	0.9434	3269654
Year 2	3954112	-2607796	7419945	0.89	3519146
Year 3	3966944	1359148	11386889	0.8396	3330723
Year 4	3233570	4592718	14620459	0.7921	2561290
TOTAL			14620459		12680812

The Net Present Value at 6% discount rate is 2653071

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Hp's Hp 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 Hp's Hp 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 Hewlett-Packard--Computer Systems Organization: Selling to Enterprise Customers

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 Hp's Hp 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 Hp's Hp 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	(10027741)	-10027741	-	-
Year 1	3465833	-6561908	3465833	0.8696	3013768
Year 2	3954112	-2607796	7419945	0.7561	2989877
Year 3	3966944	1359148	11386889	0.6575	2608330
Year 4	3233570	4592718	14620459	0.5718	1848804
TOTAL					10460779

The Net NPV after 4 years is 433038

(10460779 - 10027741 )

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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	(10027741)	-10027741	-	-
Year 1	3465833	-6561908	3465833	0.8333	2888194
Year 2	3954112	-2607796	7419945	0.6944	2745911
Year 3	3966944	1359148	11386889	0.5787	2295685
Year 4	3233570	4592718	14620459	0.4823	1559399
TOTAL					9489190

The Net NPV after 4 years is -538551

At 20% discount rate the NPV is negative (9489190 - 10027741 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Hp's Hp 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 Hp's Hp has a NPV value higher than Zero then finance managers at Hp's Hp 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 Hp's Hp, then the stock price of the Hp's Hp 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 Hp's Hp 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 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.

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.

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 Hewlett-Packard--Computer Systems Organization: Selling to Enterprise Customers

References & Further Readings

Das Narayandas, Robert C. Dudley (2018), "Hewlett-Packard--Computer Systems Organization: Selling to Enterprise Customers Harvard Business Review Case Study. Published by HBR Publications.