Sandvik AB (A) 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 Sandvik AB (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Sandvik AB (A) case study is a Harvard Business School (HBR) case study written by Julian Birkinshaw, Roderick E. White, Robin Teigland. The Sandvik AB (A) (referred as “Sandvik Synergies” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Competitive strategy, Risk management.

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 Sandvik AB (A) Case Study

The CEO of Sandvik Group is reviewing the initiatives he implemented since assuming leadership of the group. The case focuses on his attempts to increase the synergies between the six disparate businesses of the Sandvik Group. Also briefly describes the history of the company followed by a description of the businesses and corporate management of Sandvik. Specific measures taken by Sandvik's management to increase the level of synergy between the businesses are outlined. Concludes with a discussion of the problems and challenges management has experienced in connection with the search for synergy. The main challenge is how to avoid a recentralization of power while at the same time encouraging employees to act with regard to both their business and the group. Closes with the CEO wondering how further changes could be made to expand and sustain the search and exploitation of synergies within the Sandvik group. Written for use in Business Policy/Strategy courses in the second year of an MBA program. Can be used as a corporate strategy case to illustrate concepts such as diversification, synergies, and parenting advantage. Can also be used as a management of change case by putting emphasis on the actions of the CEO can take to achieve his stated goals.

Case Authors : Julian Birkinshaw, Roderick E. White, Robin Teigland

Topic : Strategy & Execution

Related Areas : Competitive strategy, Risk management

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Calculating Net Present Value (NPV) at 6% for Sandvik AB (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10021938)	-10021938	-	-
Year 1	3462673	-6559265	3462673	0.9434	3266673
Year 2	3958515	-2600750	7421188	0.89	3523064
Year 3	3936781	1336031	11357969	0.8396	3305397
Year 4	3250178	4586209	14608147	0.7921	2574445
TOTAL			14608147		12669580

The Net Present Value at 6% discount rate is 2647642

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. Payback Period
4. Internal Rate of Return

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. Sandvik Synergies 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 Sandvik Synergies 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 Sandvik AB (A)

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 Sandvik Synergies 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 Sandvik Synergies 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	(10021938)	-10021938	-	-
Year 1	3462673	-6559265	3462673	0.8696	3011020
Year 2	3958515	-2600750	7421188	0.7561	2993206
Year 3	3936781	1336031	11357969	0.6575	2588497
Year 4	3250178	4586209	14608147	0.5718	1858300
TOTAL					10451023

The Net NPV after 4 years is 429085

(10451023 - 10021938 )

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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	(10021938)	-10021938	-	-
Year 1	3462673	-6559265	3462673	0.8333	2885561
Year 2	3958515	-2600750	7421188	0.6944	2748969
Year 3	3936781	1336031	11357969	0.5787	2278230
Year 4	3250178	4586209	14608147	0.4823	1567408
TOTAL					9480168

The Net NPV after 4 years is -541770

At 20% discount rate the NPV is negative (9480168 - 10021938 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Sandvik Synergies 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 Sandvik Synergies has a NPV value higher than Zero then finance managers at Sandvik Synergies 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 Sandvik Synergies, then the stock price of the Sandvik Synergies 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 Sandvik Synergies 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.

What can impact the cash flow of the project.

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.

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 Sandvik AB (A)

References & Further Readings

Julian Birkinshaw, Roderick E. White, Robin Teigland (2018), "Sandvik AB (A) Harvard Business Review Case Study. Published by HBR Publications.