Go2xpert Ltd.: Finding the Right China Strategy 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 Go2xpert Ltd.: Finding the Right China Strategy case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Go2xpert Ltd.: Finding the Right China Strategy case study is a Harvard Business School (HBR) case study written by Ali Simon Lam, Vincent Mak, Pauline Ng. The Go2xpert Ltd.: Finding the Right China Strategy (referred as “Siu Go2xpert” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Corporate governance, Entrepreneurial management, Marketing, 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 Go2xpert Ltd.: Finding the Right China Strategy Case Study

In January 2000, when the Internet boom was sweeping Hong Kong, Nelson Siu and a few friends started a recruitment Web site called Go2xpert. After the Internet bubble burst, Siu and his colleagues changed their business strategy. They saw an opportunity in the niche market of helping Hong Kong companies recruit mainland Chinese professionals. However, Siu soon found himself in a business cul-de-sac doing that type of business, primarily due to complicated immigration procedures and requirements for mainland professionals relocating to Hong Kong. They had to change strategy again, but in which direction? Illustrates how Hong Kong SME entrepreneurs can find the right opportunities offered by the Chinese market. Sheds light on how SMEs need to change their strategy, manage their operations, and market their business to make the best use of a rapidly changing business environment.

Case Authors : Ali Simon Lam, Vincent Mak, Pauline Ng

Topic : Strategy & Execution

Related Areas : Corporate governance, Entrepreneurial management, Marketing, Strategy

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Calculating Net Present Value (NPV) at 6% for Go2xpert Ltd.: Finding the Right China Strategy Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10008628)	-10008628	-	-
Year 1	3470101	-6538527	3470101	0.9434	3273680
Year 2	3972458	-2566069	7442559	0.89	3535473
Year 3	3952337	1386268	11394896	0.8396	3318458
Year 4	3222027	4608295	14616923	0.7921	2552147
TOTAL			14616923		12679759

The Net Present Value at 6% discount rate is 2671131

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. 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 Siu Go2xpert 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. Siu Go2xpert 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 Go2xpert Ltd.: Finding the Right China Strategy

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 Siu Go2xpert 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 Siu Go2xpert 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	(10008628)	-10008628	-	-
Year 1	3470101	-6538527	3470101	0.8696	3017479
Year 2	3972458	-2566069	7442559	0.7561	3003749
Year 3	3952337	1386268	11394896	0.6575	2598726
Year 4	3222027	4608295	14616923	0.5718	1842204
TOTAL					10462158

The Net NPV after 4 years is 453530

(10462158 - 10008628 )

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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	(10008628)	-10008628	-	-
Year 1	3470101	-6538527	3470101	0.8333	2891751
Year 2	3972458	-2566069	7442559	0.6944	2758651
Year 3	3952337	1386268	11394896	0.5787	2287232
Year 4	3222027	4608295	14616923	0.4823	1553832
TOTAL					9491467

The Net NPV after 4 years is -517161

At 20% discount rate the NPV is negative (9491467 - 10008628 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Siu Go2xpert 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 Siu Go2xpert has a NPV value higher than Zero then finance managers at Siu Go2xpert 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 Siu Go2xpert, then the stock price of the Siu Go2xpert 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 Siu Go2xpert 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 can impact the cash flow of 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.

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 Go2xpert Ltd.: Finding the Right China Strategy

References & Further Readings

Ali Simon Lam, Vincent Mak, Pauline Ng (2018), "Go2xpert Ltd.: Finding the Right China Strategy Harvard Business Review Case Study. Published by HBR Publications.