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Entrepreneur's Path to Global Expansion 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 Entrepreneur's Path to Global Expansion case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Entrepreneur's Path to Global Expansion case study is a Harvard Business School (HBR) case study written by Walter Kuemmerle. The Entrepreneur's Path to Global Expansion (referred as “Local Resources” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Growth strategy, International business, Operations management, Strategic planning.

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 Entrepreneur's Path to Global Expansion Case Study


This is an MIT Sloan Management Review article. Most start-up companies today consider overseas expansion from their inception. Yet, says the author, entrepreneurs and their managers often underestimate the cost of expansion and lack a clear conceptual framework for it. On the basis of studying 50 entrepreneurial ventures in more than 20 countries, the author concludes that such ventures follow a variety of different expansion paths. The most successful are those that best manage the constant tensions between resources and opportunities, each of which run the gamut from purely local to worldwide. Offers a framework that defines the choices a venture has at its inception and throughout its life and shows how to use the framework to assess and direct a venture and mitigate developing tensions by anticipating a variety of strategic, financial, organizational, and regulatory factors. Uses case examples of a software company that took a balanced or "diagonal" path (the most common), an air-freight delivery service that progressed from pursuing local opportunities with local resources to pursuing cross-border opportunities with local resources, and a consumer-loan provider that began by pursuing a local opportunity with local resources, then added cross-border resources.


Case Authors : Walter Kuemmerle

Topic : Strategy & Execution

Related Areas : Growth strategy, International business, Operations management, Strategic planning




Calculating Net Present Value (NPV) at 6% for Entrepreneur's Path to Global Expansion Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10028600) -10028600 - -
Year 1 3456622 -6571978 3456622 0.9434 3260964
Year 2 3960003 -2611975 7416625 0.89 3524389
Year 3 3962040 1350065 11378665 0.8396 3326605
Year 4 3245271 4595336 14623936 0.7921 2570559
TOTAL 14623936 12682517




The Net Present Value at 6% discount rate is 2653917

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. Internal Rate of Return
3. Profitability Index
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. Local Resources 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 Local Resources 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 Entrepreneur's Path to Global Expansion

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 Local Resources 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 Local Resources 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 (10028600) -10028600 - -
Year 1 3456622 -6571978 3456622 0.8696 3005758
Year 2 3960003 -2611975 7416625 0.7561 2994331
Year 3 3962040 1350065 11378665 0.6575 2605106
Year 4 3245271 4595336 14623936 0.5718 1855494
TOTAL 10460689


The Net NPV after 4 years is 432089

(10460689 - 10028600 )








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 (10028600) -10028600 - -
Year 1 3456622 -6571978 3456622 0.8333 2880518
Year 2 3960003 -2611975 7416625 0.6944 2750002
Year 3 3962040 1350065 11378665 0.5787 2292847
Year 4 3245271 4595336 14623936 0.4823 1565042
TOTAL 9488410


The Net NPV after 4 years is -540190

At 20% discount rate the NPV is negative (9488410 - 10028600 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Local Resources 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 Local Resources has a NPV value higher than Zero then finance managers at Local Resources 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 Local Resources, then the stock price of the Local Resources 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 Local Resources 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.

Understanding of risks involved in the project.

What can impact the cash flow of the project.

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.

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 Entrepreneur's Path to Global Expansion

References & Further Readings

Walter Kuemmerle (2018), "Entrepreneur's Path to Global Expansion Harvard Business Review Case Study. Published by HBR Publications.


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