Hong Kong Economic Times Group: Diversification and Differentiation 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 Hong Kong Economic Times Group: Diversification and Differentiation case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Hong Kong Economic Times Group: Diversification and Differentiation case study is a Harvard Business School (HBR) case study written by Ali Farhoomand, Yuen-ming Chan, Pauline Ng. The Hong Kong Economic Times Group: Diversification and Differentiation (referred as “Hket Newspaper” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Diversity, Financial management, Growth strategy, 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 Hong Kong Economic Times Group: Diversification and Differentiation Case Study

Founded in 1988 and chaired by Lawrence Fung, the Hong Kong Economic Times Group ("HKET Group") started off as a publisher of Hong Kong Economics Times (HKET)-the first Chinese-language financial newspaper in Hong Kong. Launched when the city's economy was booming, the newspaper set out to be the Chinese-language equivalent of the Financial Times and to become one of the pre-eminent financial and business information and service providers in Greater China. Widely recognized for its quality content and leading market status, Hong Kong Economic Times has evolved closely with the economic and business environment of the city, catering to the changing needs of the local business community, such as the addition of a property section during the rise of the property market in the early 1990s and an IT section during the dotcom bubble in the mid- to late 1990s. In the face of new challenges to traditional newspaper industry like the proliferation of the Internet, the HKET Group responds by focusing on two fundamental driving forces that have become the pillars to its success: diversification and differentiation. With a vision to becoming a diversified media group, HKET has branched out to book publishing, multimedia services, electronic information services, recruitment advertising and training. Set in 2006, this case addresses the changes faced by the print newspaper industry and HKET's market positioning amid such changes. The case explores the role of creativity, especially in the context of Blue Ocean Strategy. It can also be used to teach differentiation strategy and entrepreneurship. All of these concepts can be discussed within the context of a corporate culture that creates a healthy environment for business growth.

Case Authors : Ali Farhoomand, Yuen-ming Chan, Pauline Ng

Topic : Strategy & Execution

Related Areas : Diversity, Financial management, Growth strategy, Sales

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Calculating Net Present Value (NPV) at 6% for Hong Kong Economic Times Group: Diversification and Differentiation Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10027531)	-10027531	-	-
Year 1	3455206	-6572325	3455206	0.9434	3259628
Year 2	3978150	-2594175	7433356	0.89	3540539
Year 3	3936819	1342644	11370175	0.8396	3305429
Year 4	3238515	4581159	14608690	0.7921	2565207
TOTAL			14608690		12670804

The Net Present Value at 6% discount rate is 2643273

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. Timing of the expected cash flows – stockholders of Hket Newspaper have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Hket Newspaper shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Hong Kong Economic Times Group: Diversification and Differentiation

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 Hket Newspaper 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 Hket Newspaper 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	(10027531)	-10027531	-	-
Year 1	3455206	-6572325	3455206	0.8696	3004527
Year 2	3978150	-2594175	7433356	0.7561	3008053
Year 3	3936819	1342644	11370175	0.6575	2588522
Year 4	3238515	4581159	14608690	0.5718	1851631
TOTAL					10452734

The Net NPV after 4 years is 425203

(10452734 - 10027531 )

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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	(10027531)	-10027531	-	-
Year 1	3455206	-6572325	3455206	0.8333	2879338
Year 2	3978150	-2594175	7433356	0.6944	2762604
Year 3	3936819	1342644	11370175	0.5787	2278252
Year 4	3238515	4581159	14608690	0.4823	1561784
TOTAL					9481978

The Net NPV after 4 years is -545553

At 20% discount rate the NPV is negative (9481978 - 10027531 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Hket Newspaper 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 Hket Newspaper has a NPV value higher than Zero then finance managers at Hket Newspaper 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 Hket Newspaper, then the stock price of the Hket Newspaper 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 Hket Newspaper 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 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 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.

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.

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Negotiation Strategy of Hong Kong Economic Times Group: Diversification and Differentiation

References & Further Readings

Ali Farhoomand, Yuen-ming Chan, Pauline Ng (2018), "Hong Kong Economic Times Group: Diversification and Differentiation Harvard Business Review Case Study. Published by HBR Publications.