×




Teradyne: The Aurora Project 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 Teradyne: The Aurora Project case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Teradyne: The Aurora Project case study is a Harvard Business School (HBR) case study written by Joseph L. Bower. The Teradyne: The Aurora Project (referred as “Teradyne Details.three” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Customers, Entrepreneurship, Product development, Technology.

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 Teradyne: The Aurora Project Case Study


This case is accompanied by a Video Short that can be shown in class or included in a digital coursepack. Instructors should consider the timing of making the video available to students, as it may reveal key case details.Three cases deal with the introduction of a new product to Teradyne's line of semiconductor test equipment. Teradyne: Managing Strategic Change provides historic and administrative background for the other two cases. This case deals with the problems facing the head of a start-up division responsible for developing and bringing to market a new product based on technology deemed very important to the future but unattractive to present customers and, therefore, the operating divisions. This revision is shorter and provides a simpler description of the technology involved. Teradyne: Managing Disruptive Change deals with the same set of problems from the perspective of corporate management--in particular why the skunk works approach was necessary and what new problems this approach creates even if the project is successful.


Case Authors : Joseph L. Bower

Topic : Strategy & Execution

Related Areas : Customers, Entrepreneurship, Product development, Technology




Calculating Net Present Value (NPV) at 6% for Teradyne: The Aurora Project Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10029996) -10029996 - -
Year 1 3445769 -6584227 3445769 0.9434 3250725
Year 2 3959732 -2624495 7405501 0.89 3524147
Year 3 3940911 1316416 11346412 0.8396 3308865
Year 4 3226383 4542799 14572795 0.7921 2555598
TOTAL 14572795 12639335




The Net Present Value at 6% discount rate is 2609339

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. Profitability Index
3. Payback Period
4. Net Present Value

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. Teradyne Details.three 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 Teradyne Details.three 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 Teradyne: The Aurora Project

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 Teradyne Details.three 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 Teradyne Details.three 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 (10029996) -10029996 - -
Year 1 3445769 -6584227 3445769 0.8696 2996321
Year 2 3959732 -2624495 7405501 0.7561 2994126
Year 3 3940911 1316416 11346412 0.6575 2591213
Year 4 3226383 4542799 14572795 0.5718 1844695
TOTAL 10426355


The Net NPV after 4 years is 396359

(10426355 - 10029996 )








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 (10029996) -10029996 - -
Year 1 3445769 -6584227 3445769 0.8333 2871474
Year 2 3959732 -2624495 7405501 0.6944 2749814
Year 3 3940911 1316416 11346412 0.5787 2280620
Year 4 3226383 4542799 14572795 0.4823 1555933
TOTAL 9457841


The Net NPV after 4 years is -572155

At 20% discount rate the NPV is negative (9457841 - 10029996 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Teradyne Details.three 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 Teradyne Details.three has a NPV value higher than Zero then finance managers at Teradyne Details.three 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 Teradyne Details.three, then the stock price of the Teradyne Details.three 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 Teradyne Details.three 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 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 can impact the cash flow of the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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.






Negotiation Strategy of Teradyne: The Aurora Project

References & Further Readings

Joseph L. Bower (2018), "Teradyne: The Aurora Project Harvard Business Review Case Study. Published by HBR Publications.


Ratti SWOT Analysis / TOWS Matrix

Consumer Cyclical , Apparel/Accessories


Kinder Morgan SWOT Analysis / TOWS Matrix

Utilities , Natural Gas Utilities


Nanogate AG SWOT Analysis / TOWS Matrix

Basic Materials , Chemical Manufacturing


Ya-Man SWOT Analysis / TOWS Matrix

Consumer Cyclical , Appliance & Tool


Hansol CNP SWOT Analysis / TOWS Matrix

Basic Materials , Chemical Manufacturing


Cosmo Films Ltd SWOT Analysis / TOWS Matrix

Basic Materials , Containers & Packaging


Jayex Healthcare Ltd SWOT Analysis / TOWS Matrix

Technology , Software & Programming


Abbey SWOT Analysis / TOWS Matrix

Capital Goods , Construction Services


Garuda Maintenance Facility SWOT Analysis / TOWS Matrix

Transportation , Misc. Transportation


Westminster SWOT Analysis / TOWS Matrix

Services , Security Systems & Services


Zip SWOT Analysis / TOWS Matrix

Financial , Consumer Financial Services