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Aegis Analytical Corporation's Strategic Alliances 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 Aegis Analytical Corporation's Strategic Alliances case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Aegis Analytical Corporation's Strategic Alliances case study is a Harvard Business School (HBR) case study written by Paul M. Olk, Joan Winn. The Aegis Analytical Corporation's Strategic Alliances (referred as “Aegis Aegis's” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Marketing, Venture capital.

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 Aegis Analytical Corporation's Strategic Alliances Case Study


Aegis Analytical Corporation was founded in 1995 by Gretchen L. Jahn and Justin O. Neway to provide process manufacturing software and consulting services to pharmaceutical and biotech manufacturers. Aegis developed a software program that quickly compiles disparate data into a single report. Within minutes, the program develops reports on drug tests and manufacturing quality that previously might take months to compile. With a target market of large pharmaceutical manufacturers, Aegis knew it faced a challenge of getting "in the door" of these companies and of convincing them that Aegis and its software would be around for awhile. To help with the marketing, Aegis formed two alliances with two companies that manufactured and sold complementary products to pharmaceutical manufacturing companies. While there were advantages to partnering with these divisions of Honeywell and Rockwell, most notably the visibility and credibility that these big names offered, many disadvantages developed. Most important is that Aegis's product was just one of many that Honeywell or Rockwell would promote. While there were incentives in place to encourage Honeywell and Rockwell to promote Aegis's product, after a year neither strategic alliance had resulted in a sale of Aegis's software. Aegis's founders were faced with the decisions of whether they should continue with either or both of the alliances. If they chose to continue the alliances, what could they as a small company do to encourage their much larger partners to promote the Aegis product? If they chose to terminate the alliances, can they rely only upon their internal sales staff to adequately promote and sell their product? What would be the effect on their reputation by no longer partnering with Rockwell or Honeywell? Another option might be to attempt to set up new alliances? If so, what steps should they take to increase the probability of success?


Case Authors : Paul M. Olk, Joan Winn

Topic : Strategy & Execution

Related Areas : Marketing, Venture capital




Calculating Net Present Value (NPV) at 6% for Aegis Analytical Corporation's Strategic Alliances Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10017129) -10017129 - -
Year 1 3451952 -6565177 3451952 0.9434 3256558
Year 2 3961571 -2603606 7413523 0.89 3525784
Year 3 3954612 1351006 11368135 0.8396 3320368
Year 4 3248968 4599974 14617103 0.7921 2573487
TOTAL 14617103 12676198




The Net Present Value at 6% discount rate is 2659069

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. Payback Period
2. Profitability Index
3. Net Present Value
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 Aegis Aegis's 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. Aegis Aegis's shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of Aegis Analytical Corporation's Strategic Alliances

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 Aegis Aegis's 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 Aegis Aegis's 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 (10017129) -10017129 - -
Year 1 3451952 -6565177 3451952 0.8696 3001697
Year 2 3961571 -2603606 7413523 0.7561 2995517
Year 3 3954612 1351006 11368135 0.6575 2600222
Year 4 3248968 4599974 14617103 0.5718 1857608
TOTAL 10455044


The Net NPV after 4 years is 437915

(10455044 - 10017129 )








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 (10017129) -10017129 - -
Year 1 3451952 -6565177 3451952 0.8333 2876627
Year 2 3961571 -2603606 7413523 0.6944 2751091
Year 3 3954612 1351006 11368135 0.5787 2288549
Year 4 3248968 4599974 14617103 0.4823 1566825
TOTAL 9483091


The Net NPV after 4 years is -534038

At 20% discount rate the NPV is negative (9483091 - 10017129 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Aegis Aegis's 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 Aegis Aegis's has a NPV value higher than Zero then finance managers at Aegis Aegis's 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 Aegis Aegis's, then the stock price of the Aegis Aegis's 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 Aegis Aegis's 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 will be a multi year spillover effect of various taxation regulations.

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.

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 Aegis Analytical Corporation's Strategic Alliances

References & Further Readings

Paul M. Olk, Joan Winn (2018), "Aegis Analytical Corporation's Strategic Alliances Harvard Business Review Case Study. Published by HBR Publications.


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