Alcatel in China: Business as an Adventure 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 Alcatel in China: Business as an Adventure case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Alcatel in China: Business as an Adventure case study is a Harvard Business School (HBR) case study written by William A. Fischer, Denis F. Simon, Katherine Xin, Janet Carmosky. The Alcatel in China: Business as an Adventure (referred as “Alcatel Brawn” 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, 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 Alcatel in China: Business as an Adventure Case Study

Take the world's most challenging market. Concentrate almost all your previously dispersed assets--12 joint ventures and wholly owned businesses--into one basket. Move the management of all of your regional activities to this location. Place access to your worldwide intellectual property on the table, and add $312 million for the portion of equity in a joint venture that gets you up to 50% plus one share. Then turn the venture's structure and governance on its head to build not only the most technically and sales-aggressive telecom competitor in the Chinese market, but one that also gives you access to Chinese brains and brawn in producing a global product for the global market. A recipe for revolution across the global marketplace or yet another misguided investment in China's elusive dream? Alcatel, France's venerable telecom giant, is betting the former. A 2004 EFMD award winner.

Case Authors : William A. Fischer, Denis F. Simon, Katherine Xin, Janet Carmosky

Topic : Strategy & Execution

Related Areas : Intellectual property, Joint ventures, Strategic planning

Calculating Net Present Value (NPV) at 6% for Alcatel in China: Business as an Adventure Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10004022) -10004022 - -
Year 1 3458336 -6545686 3458336 0.9434 3262581
Year 2 3961002 -2584684 7419338 0.89 3525278
Year 3 3962102 1377418 11381440 0.8396 3326657
Year 4 3238881 4616299 14620321 0.7921 2565497
TOTAL 14620321 12680013

The Net Present Value at 6% discount rate is 2675991

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. Alcatel Brawn 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 Alcatel Brawn 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 Alcatel in China: Business as an Adventure

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 Alcatel Brawn 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 Alcatel Brawn 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 %
Cash Flows
Year 0 (10004022) -10004022 - -
Year 1 3458336 -6545686 3458336 0.8696 3007249
Year 2 3961002 -2584684 7419338 0.7561 2995087
Year 3 3962102 1377418 11381440 0.6575 2605146
Year 4 3238881 4616299 14620321 0.5718 1851841
TOTAL 10459322

The Net NPV after 4 years is 455300

(10459322 - 10004022 )

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 %
Cash Flows
Year 0 (10004022) -10004022 - -
Year 1 3458336 -6545686 3458336 0.8333 2881947
Year 2 3961002 -2584684 7419338 0.6944 2750696
Year 3 3962102 1377418 11381440 0.5787 2292883
Year 4 3238881 4616299 14620321 0.4823 1561960
TOTAL 9487486

The Net NPV after 4 years is -516536

At 20% discount rate the NPV is negative (9487486 - 10004022 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Alcatel Brawn 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 Alcatel Brawn has a NPV value higher than Zero then finance managers at Alcatel Brawn 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 Alcatel Brawn, then the stock price of the Alcatel Brawn 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 Alcatel Brawn 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 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.

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.

References & Further Readings

William A. Fischer, Denis F. Simon, Katherine Xin, Janet Carmosky (2018), "Alcatel in China: Business as an Adventure Harvard Business Review Case Study. Published by HBR Publications.