3M Taiwan: Product Innovation in the Subsidiary 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 3M Taiwan: Product Innovation in the Subsidiary case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. 3M Taiwan: Product Innovation in the Subsidiary case study is a Harvard Business School (HBR) case study written by Christopher Williams, Liaw Emily. The 3M Taiwan: Product Innovation in the Subsidiary (referred as “Acne Dressing” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Innovation, International business, Project management, Strategy.

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 3M Taiwan: Product Innovation in the Subsidiary Case Study

On January 17, 2005, the function head in the Health Care Business in 3M Taiwan, found himself in a meeting with the Acne Dressing project team. In 2004, the function head initiated a project team to exploit local market needs for 3M Hydrocolloid Dressing, a technology that existed in the company for many years without any practical applications. The local project team suggested applying the material for acne treatment. The product would be known as Acne Dressing. There was no standardized solution for acne treatment in Taiwan. If developed, Acne Dressing would be a brand new product in the local market. The biggest challenge would be how to change local consumer behaviors on new acne treatment products. In addition, since there were no similar products in the market, the project team only had limited information. The potential sales and volume estimation were all uncertain. If the local development were to be launched, Acne Dressing would be 3M's first product application from Hydrocolloid Dressing technology. With little previous experience in product development and no similar products existing in the market, the function head had to decide fast whether to proceed with this new product development. Should the team carry on with the project? If so, what options did the local project team have? What kind of resources and support should the local Health Care business segment seek from the headquarters for the product development? Should the local product development collaborate with other subsidiaries?

Case Authors : Christopher Williams, Liaw Emily

Topic : Strategy & Execution

Related Areas : Innovation, International business, Project management, Strategy

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Calculating Net Present Value (NPV) at 6% for 3M Taiwan: Product Innovation in the Subsidiary Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10023421)	-10023421	-	-
Year 1	3456592	-6566829	3456592	0.9434	3260936
Year 2	3971277	-2595552	7427869	0.89	3534422
Year 3	3967344	1371792	11395213	0.8396	3331059
Year 4	3239316	4611108	14634529	0.7921	2565842
TOTAL			14634529		12692258

The Net Present Value at 6% discount rate is 2668837

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. Profitability Index
2. Net Present Value
3. Internal Rate of Return
4. Payback Period

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 Acne Dressing 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. Acne Dressing 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 3M Taiwan: Product Innovation in the Subsidiary

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 Acne Dressing 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 Acne Dressing 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	(10023421)	-10023421	-	-
Year 1	3456592	-6566829	3456592	0.8696	3005732
Year 2	3971277	-2595552	7427869	0.7561	3002856
Year 3	3967344	1371792	11395213	0.6575	2608593
Year 4	3239316	4611108	14634529	0.5718	1852089
TOTAL					10469271

The Net NPV after 4 years is 445850

(10469271 - 10023421 )

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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	(10023421)	-10023421	-	-
Year 1	3456592	-6566829	3456592	0.8333	2880493
Year 2	3971277	-2595552	7427869	0.6944	2757831
Year 3	3967344	1371792	11395213	0.5787	2295917
Year 4	3239316	4611108	14634529	0.4823	1562170
TOTAL					9496411

The Net NPV after 4 years is -527010

At 20% discount rate the NPV is negative (9496411 - 10023421 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Acne Dressing 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 Acne Dressing has a NPV value higher than Zero then finance managers at Acne Dressing 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 Acne Dressing, then the stock price of the Acne Dressing 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 Acne Dressing 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 will be a multi year spillover effect of various taxation regulations.

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.

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 3M Taiwan: Product Innovation in the Subsidiary

References & Further Readings

Christopher Williams, Liaw Emily (2018), "3M Taiwan: Product Innovation in the Subsidiary Harvard Business Review Case Study. Published by HBR Publications.