×




Danaher Corporation, 2007-2017 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 Danaher Corporation, 2007-2017 case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Danaher Corporation, 2007-2017 case study is a Harvard Business School (HBR) case study written by John R. Wells, Gabriel Ellsworth. The Danaher Corporation, 2007-2017 (referred as “Danaher Corporation” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Business models, Business processes, Competition, Costs, Design, Financial analysis, Financial markets, Globalization, Growth strategy, Health, Joint ventures, Marketing, Mergers & acquisitions, Networking, Organizational culture, Performance measurement, Reorganization, Risk management, Succession planning, 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 Danaher Corporation, 2007-2017 Case Study


On July 2, 2016, Danaher Corporation completed the spinoff of Fortive Corporation. The previous day, Danaher's stock price had reached an all-time high. In 2015, Danaher had decided to split off its test and measurement, fuel and fleet management, and automation businesses, leaving the "new Danaher" focused on life sciences, diagnostics, dental, water quality, and product-identification businesses. It was hardly the first industrial conglomerate to spin off major divisions; Tyco International PLC, ITT Corporation, Illinois Tool Works, Johnson Controls, and Ingersoll-Rand PLC had made similar moves in recent memory. However, its peers had often experienced declining profitability or pressure from activist investors. Danaher, by contrast, had performed strongly in the years leading up to the spinoff. It had spent the previous decade strengthening its portfolio in sectors such as life sciences and dental products with acquisitions including Beckman Coulter in 2011, Nobel Biocare Holding AG in 2014, and Pall Corporation in 2015.


Case Authors : John R. Wells, Gabriel Ellsworth

Topic : Strategy & Execution

Related Areas : Business models, Business processes, Competition, Costs, Design, Financial analysis, Financial markets, Globalization, Growth strategy, Health, Joint ventures, Marketing, Mergers & acquisitions, Networking, Organizational culture, Performance measurement, Reorganization, Risk management, Succession planning, Technology




Calculating Net Present Value (NPV) at 6% for Danaher Corporation, 2007-2017 Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10009480) -10009480 - -
Year 1 3466902 -6542578 3466902 0.9434 3270662
Year 2 3970523 -2572055 7437425 0.89 3533751
Year 3 3959699 1387644 11397124 0.8396 3324640
Year 4 3232940 4620584 14630064 0.7921 2560791
TOTAL 14630064 12689845


The Net Present Value at 6% discount rate is 2680365

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. Net Present Value
2. Payback Period
3. Profitability Index
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 Danaher Corporation 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. Danaher Corporation 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 Danaher Corporation, 2007-2017

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 Danaher Corporation 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 Danaher Corporation 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 (10009480) -10009480 - -
Year 1 3466902 -6542578 3466902 0.8696 3014697
Year 2 3970523 -2572055 7437425 0.7561 3002286
Year 3 3959699 1387644 11397124 0.6575 2603566
Year 4 3232940 4620584 14630064 0.5718 1848444
TOTAL 10468994


The Net NPV after 4 years is 459514

(10468994 - 10009480 )






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 (10009480) -10009480 - -
Year 1 3466902 -6542578 3466902 0.8333 2889085
Year 2 3970523 -2572055 7437425 0.6944 2757308
Year 3 3959699 1387644 11397124 0.5787 2291492
Year 4 3232940 4620584 14630064 0.4823 1559095
TOTAL 9496980


The Net NPV after 4 years is -512500

At 20% discount rate the NPV is negative (9496980 - 10009480 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Danaher Corporation 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 Danaher Corporation has a NPV value higher than Zero then finance managers at Danaher Corporation 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 Danaher Corporation, then the stock price of the Danaher Corporation 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 Danaher Corporation 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 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 can impact the cash flow of 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.




References & Further Readings

John R. Wells, Gabriel Ellsworth (2018), "Danaher Corporation, 2007-2017 Harvard Business Review Case Study. Published by HBR Publications.