Black & Decker Corp.: Compact Power--Innovation in the Cordless Professional Drill and Driver market 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 Black & Decker Corp.: Compact Power--Innovation in the Cordless Professional Drill and Driver market case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Black & Decker Corp.: Compact Power--Innovation in the Cordless Professional Drill and Driver market case study is a Harvard Business School (HBR) case study written by Thomas Walton. The Black & Decker Corp.: Compact Power--Innovation in the Cordless Professional Drill and Driver market (referred as “Drill Cordless” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Leading teams, Marketing, Product development, Project management.

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

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Case Description of Black & Decker Corp.: Compact Power--Innovation in the Cordless Professional Drill and Driver market Case Study

Executives at Black & Decker Corp. challenge managers to design and develop a cordless electric power drill for professionals that will enhance its reputation among that group of users and significantly lift the company's share of that market. Moreover, the new product must have a platform that, with modest changes, will suit both the North American and European markets. Like many such projects, the time line is short. The management challenge is to put together an international team and develop strategies for defining competitive opportunities, refining program objectives, ensuring effective communication, and keeping people focused. Designers--including engineers and product designers--must overcome a series of technical challenges related to the power the drill will deliver, battery location, and ergonomics. Models are a key design tool in the development process and are used to test consumer reactions in both North America and Europe.

Case Authors : Thomas Walton

Topic : Strategy & Execution

Related Areas : Leading teams, Marketing, Product development, Project management

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Calculating Net Present Value (NPV) at 6% for Black & Decker Corp.: Compact Power--Innovation in the Cordless Professional Drill and Driver market Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012856)	-10012856	-	-
Year 1	3471760	-6541096	3471760	0.9434	3275245
Year 2	3957197	-2583899	7428957	0.89	3521891
Year 3	3967020	1383121	11395977	0.8396	3330786
Year 4	3238375	4621496	14634352	0.7921	2565096
TOTAL			14634352		12693019

The Net Present Value at 6% discount rate is 2680163

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.

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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. Net Present Value
4. Profitability Index

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 Drill Cordless 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. Drill Cordless shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Black & Decker Corp.: Compact Power--Innovation in the Cordless Professional Drill and Driver market

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 Drill Cordless 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 Drill Cordless 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	(10012856)	-10012856	-	-
Year 1	3471760	-6541096	3471760	0.8696	3018922
Year 2	3957197	-2583899	7428957	0.7561	2992209
Year 3	3967020	1383121	11395977	0.6575	2608380
Year 4	3238375	4621496	14634352	0.5718	1851551
TOTAL					10471063

The Net NPV after 4 years is 458207

(10471063 - 10012856 )

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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	(10012856)	-10012856	-	-
Year 1	3471760	-6541096	3471760	0.8333	2893133
Year 2	3957197	-2583899	7428957	0.6944	2748053
Year 3	3967020	1383121	11395977	0.5787	2295729
Year 4	3238375	4621496	14634352	0.4823	1561716
TOTAL					9498632

The Net NPV after 4 years is -514224

At 20% discount rate the NPV is negative (9498632 - 10012856 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Drill Cordless 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 Drill Cordless has a NPV value higher than Zero then finance managers at Drill Cordless 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 Drill Cordless, then the stock price of the Drill Cordless 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 Drill Cordless 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 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.

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.

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Negotiation Strategy of Black & Decker Corp.: Compact Power--Innovation in the Cordless Professional Drill and Driver market

References & Further Readings

Thomas Walton (2018), "Black & Decker Corp.: Compact Power--Innovation in the Cordless Professional Drill and Driver market Harvard Business Review Case Study. Published by HBR Publications.