BeyoncA? 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 BeyoncA? case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. BeyoncA? case study is a Harvard Business School (HBR) case study written by Anita Elberse, Stacie Smith. The BeyoncA? (referred as “Album Music” 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 BeyoncA? Case Study

In December 2013, music superstar BeyoncA? is about to surprise her fans with the release of her self-titled album. The team at her company Parkwood Entertainment, which general manager Lee Anne Callahan-Longo described as "a management, music, and production company that is owned and at the highest level operated by an artist," had chosen to release the entire album at once and exclusively via the Apple iTunes Store, without any prior promotion-a significant, and potentially very risky, departure from how music was traditionally released. Sony Music's label Columbia Records, with whom Parkwood partnered on recorded-music activities, shared the costs-and therefore also the risk-of the album, which had been one-and-a-half years in development and was a particularly expensive proposition because of the many videos. How would fans and music industry insiders react to the daring launch, unveiled via BeyoncA?'s Facebook and Instagram accounts? Would the album be able to find a large enough audience even without traditional promotional activities? And would there be any adverse reactions, for instance from traditional music retailers refusing to carry the physical album later?

Case Authors : Anita Elberse, Stacie Smith

Topic : Sales & Marketing

Related Areas : Technology

Calculating Net Present Value (NPV) at 6% for BeyoncA? Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10029072) -10029072 - -
Year 1 3465292 -6563780 3465292 0.9434 3269143
Year 2 3970834 -2592946 7436126 0.89 3534028
Year 3 3954310 1361364 11390436 0.8396 3320115
Year 4 3229836 4591200 14620272 0.7921 2558333
TOTAL 14620272 12681619

The Net Present Value at 6% discount rate is 2652547

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. Payback Period
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. Album Music 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 Album Music have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

Formula and Steps to Calculate Net Present Value (NPV) of BeyoncA?

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 Album Music 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 Album Music 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 %
Cash Flows
Year 0 (10029072) -10029072 - -
Year 1 3465292 -6563780 3465292 0.8696 3013297
Year 2 3970834 -2592946 7436126 0.7561 3002521
Year 3 3954310 1361364 11390436 0.6575 2600023
Year 4 3229836 4591200 14620272 0.5718 1846669
TOTAL 10462511

The Net NPV after 4 years is 433439

(10462511 - 10029072 )

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 %
Cash Flows
Year 0 (10029072) -10029072 - -
Year 1 3465292 -6563780 3465292 0.8333 2887743
Year 2 3970834 -2592946 7436126 0.6944 2757524
Year 3 3954310 1361364 11390436 0.5787 2288374
Year 4 3229836 4591200 14620272 0.4823 1557598
TOTAL 9491239

The Net NPV after 4 years is -537833

At 20% discount rate the NPV is negative (9491239 - 10029072 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Album Music 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 Album Music has a NPV value higher than Zero then finance managers at Album Music 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 Album Music, then the stock price of the Album Music 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 Album Music 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 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 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.

Negotiation Strategy of BeyoncA?

References & Further Readings

Anita Elberse, Stacie Smith (2018), "BeyoncA? Harvard Business Review Case Study. Published by HBR Publications.

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