Shimano and the High-End Road Bike Industry 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 Shimano and the High-End Road Bike Industry case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Shimano and the High-End Road Bike Industry case study is a Harvard Business School (HBR) case study written by Garth Saloner, Victoria Chang. The Shimano and the High-End Road Bike Industry (referred as “Bike Shimano” 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, Strategy execution.

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 Shimano and the High-End Road Bike Industry Case Study

Professional cycling teams use road bikes made up of several parts or components: frames, forks, wheels and tires, saddles, seat posts, handlebars, and pedals. Pedals hold a cyclist's special shoes in place so they can "clip in" for greater control and power, and several companies make different models of pedals. Lance Armstrong, seven-time winner of the Tour de France, uses Shimano pedals. Shimano, founded and based in Sakai City, Japan, makes many of the key components of a bike. The fact that each of the different components to a high-end road bike are manufactured by different companies makes for a complicated bike industry supply chain. By 2006, Shimano had grown from a family-based business (founded by Shozoburo Shimano in 1920) that focused on freewheels, to a $1.6 billion global company (with net income of $186 million) that not only manufactured mid- to high-end bike components (and low-end components as well), but also made fishing tackle. Eighty percent of the company's sales were from high-end bike components and 20 % from mid-range bicycle components. Seventy-five percent of the company's earnings could be attributed to components. Shimano led the bike component industry, owning over 80 % of the high-end component market. But growth did not come overnight. Shimano's leaders reflected on the company and its growth trajectory. They were particularly proud of Shimano's market domination, largely attributable to the company's commitment to research and technology, as well as to the amount of value the company had been able to leverage from the industry's supply chain. As new technologies and new companies began to enter the market, and the longer term sales trend of a mature road bike industry remained relatively flat--despite the "Armstrong effect"--Shimano's leaders and their team wondered how to continue their growth in the mid- to high-end components market and achieve growth on an even greater global scale.

Case Authors : Garth Saloner, Victoria Chang

Topic : Strategy & Execution

Related Areas : Growth strategy, Strategy execution

Calculating Net Present Value (NPV) at 6% for Shimano and the High-End Road Bike Industry Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10021781) -10021781 - -
Year 1 3447901 -6573880 3447901 0.9434 3252737
Year 2 3973928 -2599952 7421829 0.89 3536782
Year 3 3945025 1345073 11366854 0.8396 3312319
Year 4 3225933 4571006 14592787 0.7921 2555241
TOTAL 14592787 12657079

The Net Present Value at 6% discount rate is 2635298

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. Profitability Index
2. Payback Period
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Bike Shimano 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 Bike Shimano 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 Shimano and the High-End Road Bike Industry

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 Bike Shimano 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 Bike Shimano 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 (10021781) -10021781 - -
Year 1 3447901 -6573880 3447901 0.8696 2998175
Year 2 3973928 -2599952 7421829 0.7561 3004860
Year 3 3945025 1345073 11366854 0.6575 2593918
Year 4 3225933 4571006 14592787 0.5718 1844438
TOTAL 10441391

The Net NPV after 4 years is 419610

(10441391 - 10021781 )

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 (10021781) -10021781 - -
Year 1 3447901 -6573880 3447901 0.8333 2873251
Year 2 3973928 -2599952 7421829 0.6944 2759672
Year 3 3945025 1345073 11366854 0.5787 2283001
Year 4 3225933 4571006 14592787 0.4823 1555716
TOTAL 9471640

The Net NPV after 4 years is -550141

At 20% discount rate the NPV is negative (9471640 - 10021781 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Bike Shimano 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 Bike Shimano has a NPV value higher than Zero then finance managers at Bike Shimano 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 Bike Shimano, then the stock price of the Bike Shimano 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 Bike Shimano 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 can impact the cash flow of the project.

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 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.

References & Further Readings

Garth Saloner, Victoria Chang (2018), "Shimano and the High-End Road Bike Industry Harvard Business Review Case Study. Published by HBR Publications.