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Bertelsmann AG 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 Bertelsmann AG case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Bertelsmann AG case study is a Harvard Business School (HBR) case study written by Bharat N. Anand, Michael G. Rukstad. The Bertelsmann AG (referred as “Bertelsmann Middelhoff” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Collaboration, Corporate communications, IPO, Leadership, Professional transitions, 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 Bertelsmann AG Case Study


To maximize their effectiveness, color cases should be printed in color.On July 28, 2002, Bertelsmann announced the firing of its CEO, Thomas Middelhoff, in a move that surprised industry observers, analysts, and many employees. Bertelsmann, a privately held company headquartered in Germany, was one of the largest global media conglomerates, with businesses spanning book publishing, printing, music, and television. Between 1998 and 2002, Middelhoff had initiated a series of strategic initiatives aimed at fostering greater integration among its diverse business units and strengthening their competitive positions, articulated a series of guidelines that would reevaluate Bertelsmann's portfolio mix, and looked to prepare Bertelsmann for a transition to a planned initial public offering in 2005. This case describes these initiatives in detail and the decision of the supervisory board to effect a change in leadership. The new CEO, Gunter Thielen, had to decide whether to effect a fundamental shift in the company's corporate strategy or a more modest reinterpretation of the course charted by Middelhoff. Includes color exhibits.


Case Authors : Bharat N. Anand, Michael G. Rukstad

Topic : Strategy & Execution

Related Areas : Collaboration, Corporate communications, IPO, Leadership, Professional transitions, Strategy execution




Calculating Net Present Value (NPV) at 6% for Bertelsmann AG Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10015823) -10015823 - -
Year 1 3457001 -6558822 3457001 0.9434 3261322
Year 2 3962824 -2595998 7419825 0.89 3526899
Year 3 3958455 1362457 11378280 0.8396 3323595
Year 4 3248132 4610589 14626412 0.7921 2572825
TOTAL 14626412 12684641


The Net Present Value at 6% discount rate is 2668818

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. 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 Bertelsmann Middelhoff 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. Bertelsmann Middelhoff 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 Bertelsmann AG

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 Bertelsmann Middelhoff 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 Bertelsmann Middelhoff 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 (10015823) -10015823 - -
Year 1 3457001 -6558822 3457001 0.8696 3006088
Year 2 3962824 -2595998 7419825 0.7561 2996464
Year 3 3958455 1362457 11378280 0.6575 2602748
Year 4 3248132 4610589 14626412 0.5718 1857130
TOTAL 10462431


The Net NPV after 4 years is 446608

(10462431 - 10015823 )






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 (10015823) -10015823 - -
Year 1 3457001 -6558822 3457001 0.8333 2880834
Year 2 3962824 -2595998 7419825 0.6944 2751961
Year 3 3958455 1362457 11378280 0.5787 2290773
Year 4 3248132 4610589 14626412 0.4823 1566422
TOTAL 9489990


The Net NPV after 4 years is -525833

At 20% discount rate the NPV is negative (9489990 - 10015823 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Bertelsmann Middelhoff 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 Bertelsmann Middelhoff has a NPV value higher than Zero then finance managers at Bertelsmann Middelhoff 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 Bertelsmann Middelhoff, then the stock price of the Bertelsmann Middelhoff 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 Bertelsmann Middelhoff 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 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.

Understanding of risks involved in the project.

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 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.




References & Further Readings

Bharat N. Anand, Michael G. Rukstad (2018), "Bertelsmann AG Harvard Business Review Case Study. Published by HBR Publications.