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NPV: Siemens Medical Solutions: Strategic Turnaround Net Present Value Case Analysis
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Siemens Medical Solutions: Strategic Turnaround 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 Siemens Medical Solutions: Strategic Turnaround case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Siemens Medical Solutions: Strategic Turnaround case study is a Harvard Business School (HBR) case study written by D. Quinn Mills, Julian Kurz. The Siemens Medical Solutions: Strategic Turnaround (referred as “Siemens Turnaround” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Change management, Developing employees, Growth strategy, International business, Manufacturing, Product development, 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




Case Description of Siemens Medical Solutions: Strategic Turnaround Case Study


Describes how Siemens Medical Solutions (MED) accomplished a remarkable turnaround from a money-losing operation to one of Siemens' most profitable divisions. By late 1996, a challenging market environment in the health care industry as well as inefficiencies in the company's manufacturing, logistics, and sales/service processes had a negative impact on MED's profitability. Reacting to these challenges, CEO Reinhardt defined and implemented a comprehensive turnaround program centered around people, processes, and products. The case highlights the most important aspects of the company's turnaround and later expansion and provides an outlook for the company's future challenges and opportunities.


Case Authors : D. Quinn Mills, Julian Kurz

Topic : Strategy & Execution

Related Areas : Change management, Developing employees, Growth strategy, International business, Manufacturing, Product development, Sales




Calculating Net Present Value (NPV) at 6% for Siemens Medical Solutions: Strategic Turnaround Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10010653) -10010653 - -
Year 1 3454765 -6555888 3454765 0.9434 3259212
Year 2 3967112 -2588776 7421877 0.89 3530716
Year 3 3970680 1381904 11392557 0.8396 3333859
Year 4 3230185 4612089 14622742 0.7921 2558609
TOTAL 14622742 12682396


The Net Present Value at 6% discount rate is 2671743

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. Internal Rate of Return
2. Net Present Value
3. Profitability Index
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. Siemens Turnaround 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 Siemens Turnaround 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 Siemens Medical Solutions: Strategic Turnaround

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 Strategy & Execution 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 Siemens Turnaround 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 Siemens Turnaround 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 (10010653) -10010653 - -
Year 1 3454765 -6555888 3454765 0.8696 3004143
Year 2 3967112 -2588776 7421877 0.7561 2999707
Year 3 3970680 1381904 11392557 0.6575 2610787
Year 4 3230185 4612089 14622742 0.5718 1846869
TOTAL 10461505


The Net NPV after 4 years is 450852

(10461505 - 10010653 )






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 (10010653) -10010653 - -
Year 1 3454765 -6555888 3454765 0.8333 2878971
Year 2 3967112 -2588776 7421877 0.6944 2754939
Year 3 3970680 1381904 11392557 0.5787 2297847
Year 4 3230185 4612089 14622742 0.4823 1557767
TOTAL 9489524


The Net NPV after 4 years is -521129

At 20% discount rate the NPV is negative (9489524 - 10010653 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Siemens Turnaround 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 Siemens Turnaround has a NPV value higher than Zero then finance managers at Siemens Turnaround 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 Siemens Turnaround, then the stock price of the Siemens Turnaround 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 Siemens Turnaround 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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in 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.

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.

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.




References & Further Readings

D. Quinn Mills, Julian Kurz (2018), "Siemens Medical Solutions: Strategic Turnaround Harvard Business Review Case Study. Published by HBR Publications.