Molecular Insight Pharmaceuticals: Integrated Strategy for a Development Stage Molecular Medicine Company 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 Molecular Insight Pharmaceuticals: Integrated Strategy for a Development Stage Molecular Medicine Company case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Molecular Insight Pharmaceuticals: Integrated Strategy for a Development Stage Molecular Medicine Company case study is a Harvard Business School (HBR) case study written by David P. Baron, Aneesha Capur. The Molecular Insight Pharmaceuticals: Integrated Strategy for a Development Stage Molecular Medicine Company (referred as “Mip Molecular” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Intellectual property, Joint ventures, Knowledge 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 Molecular Insight Pharmaceuticals: Integrated Strategy for a Development Stage Molecular Medicine Company Case Study

In early 2006 David Barlow, CEO of Molecular Insight Pharmaceuticals, Inc. (MIP), a development stage biopharmaceutical company, faced a set of challenges in bringing its lead product to market and in progressing its second product into the clinical trial stage. MIP researched, developed and commercialized molecular imaging pharmaceuticals and targeted radiotherapeutics to meaningfully improve patient diagnosis and care. An emerging company in the late research and development phase, MIP focused on applying its proprietary platform technologies to develop product candidates that targeted markets with significant unmet needs in the areas of cardiology, oncology and neurology. Zemiva, the company's lead cardiology product candidate for the rapid diagnosis of cardiac ischemia, had completed Phase 2b clinical trials. Azedra was a preclinical stage oncology product designed to treat a rare form of cancer-neuroendocrine tumors. In addition to developing these two products, Barlow was preparing MIP for its Initial Public Offering (IPO). This case considers the integration of market and nonmarket components in MIP's strategy for intellectual property protection, manufacturing, sales and financing product development. The case focuses on the approach MIP takes in its interactions with the Food and Drug Administration (FDA) and Congress; the Centers for Medicare and Medicaid Services (CMS); the American Medical Association (AMA) and other medical societies; and patient advocacy groups in order to garner support, obtain regulatory approval and stimulate demand for its products.

Case Authors : David P. Baron, Aneesha Capur

Topic : Strategy & Execution

Related Areas : Intellectual property, Joint ventures, Knowledge management

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Calculating Net Present Value (NPV) at 6% for Molecular Insight Pharmaceuticals: Integrated Strategy for a Development Stage Molecular Medicine Company Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012565)	-10012565	-	-
Year 1	3444218	-6568347	3444218	0.9434	3249262
Year 2	3978883	-2589464	7423101	0.89	3541192
Year 3	3957683	1368219	11380784	0.8396	3322947
Year 4	3223812	4592031	14604596	0.7921	2553561
TOTAL			14604596		12666962

The Net Present Value at 6% discount rate is 2654397

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. Internal Rate of Return
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. Timing of the expected cash flows – stockholders of Mip Molecular 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. Mip Molecular 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 Molecular Insight Pharmaceuticals: Integrated Strategy for a Development Stage Molecular Medicine Company

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 Mip Molecular 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 Mip Molecular 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	(10012565)	-10012565	-	-
Year 1	3444218	-6568347	3444218	0.8696	2994972
Year 2	3978883	-2589464	7423101	0.7561	3008607
Year 3	3957683	1368219	11380784	0.6575	2602241
Year 4	3223812	4592031	14604596	0.5718	1843225
TOTAL					10449045

The Net NPV after 4 years is 436480

(10449045 - 10012565 )

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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	(10012565)	-10012565	-	-
Year 1	3444218	-6568347	3444218	0.8333	2870182
Year 2	3978883	-2589464	7423101	0.6944	2763113
Year 3	3957683	1368219	11380784	0.5787	2290326
Year 4	3223812	4592031	14604596	0.4823	1554693
TOTAL					9478314

The Net NPV after 4 years is -534251

At 20% discount rate the NPV is negative (9478314 - 10012565 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Mip Molecular 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 Mip Molecular has a NPV value higher than Zero then finance managers at Mip Molecular 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 Mip Molecular, then the stock price of the Mip Molecular 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 Mip Molecular 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 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 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.

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 Molecular Insight Pharmaceuticals: Integrated Strategy for a Development Stage Molecular Medicine Company

References & Further Readings

David P. Baron, Aneesha Capur (2018), "Molecular Insight Pharmaceuticals: Integrated Strategy for a Development Stage Molecular Medicine Company Harvard Business Review Case Study. Published by HBR Publications.