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Three Strategies for Managing Fast Growth 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 Three Strategies for Managing Fast Growth case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Three Strategies for Managing Fast Growth case study is a Harvard Business School (HBR) case study written by Georg von Krogh, Michael A. Cusumano. The Three Strategies for Managing Fast Growth (referred as “Netscape Growth” 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, Organizational structure, Strategic planning.

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 Three Strategies for Managing Fast Growth Case Study


This is an MIT Sloan Management Review article. To grow steadily and avoid stagnation, a company must learn how to scale up and extend its business, lengthen its expansion phase, and accumulate and apply new knowledge to products and markets faster than competitors. Managers can't leave growth to chance. They need a plan that renders consistent sales growth over the long term--one that captures management's vision for expansion and that addresses the product and market combinations the company intends to pursue, the size it hopes to achieve in a particular time frame, and the know-how and organizational structures needed. Three thriving companies demonstrate three different strategies in action. The Netscape experience shows how a company can scale up--do more of what it already does well. Netscape went from $80 million in sales in 1995 to $500 million just three years later. IKEA used duplication by repeating the business model in new regions. According to the authors, IKEA's success is tied to the way it manages and transfers knowledge. SAP's growth strategy is an example of granulation--growing select business units. SAP started with a basic enterprise-resource-planning system, then moved to multiple products for e-commerce and Internet activities. Using one product as a platform, it began allowing customers to fine-tune virtually any resource-planning system. The authors emphasize the importance of combining strategies for growth with explicit strategies for learning. Companies must decide what kind of growth strategy they want to pursue, given their capabilities and market opportunities. They must then make the strategy work by changing their structure and processes in a way that lets them acquire or create specific knowledge about new technologies, customers, and industries.


Case Authors : Georg von Krogh, Michael A. Cusumano

Topic : Strategy & Execution

Related Areas : Innovation, Organizational structure, Strategic planning




Calculating Net Present Value (NPV) at 6% for Three Strategies for Managing Fast Growth Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10022006) -10022006 - -
Year 1 3465259 -6556747 3465259 0.9434 3269112
Year 2 3976336 -2580411 7441595 0.89 3538925
Year 3 3956954 1376543 11398549 0.8396 3322335
Year 4 3226333 4602876 14624882 0.7921 2555558
TOTAL 14624882 12685930




The Net Present Value at 6% discount rate is 2663924

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. Payback Period
2. Net Present Value
3. Internal Rate of Return
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 Netscape Growth 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. Netscape Growth 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 Three Strategies for Managing Fast Growth

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 Netscape Growth 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 Netscape Growth 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 (10022006) -10022006 - -
Year 1 3465259 -6556747 3465259 0.8696 3013269
Year 2 3976336 -2580411 7441595 0.7561 3006681
Year 3 3956954 1376543 11398549 0.6575 2601761
Year 4 3226333 4602876 14624882 0.5718 1844666
TOTAL 10466378


The Net NPV after 4 years is 444372

(10466378 - 10022006 )








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 (10022006) -10022006 - -
Year 1 3465259 -6556747 3465259 0.8333 2887716
Year 2 3976336 -2580411 7441595 0.6944 2761344
Year 3 3956954 1376543 11398549 0.5787 2289904
Year 4 3226333 4602876 14624882 0.4823 1555909
TOTAL 9494873


The Net NPV after 4 years is -527133

At 20% discount rate the NPV is negative (9494873 - 10022006 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Netscape Growth 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 Netscape Growth has a NPV value higher than Zero then finance managers at Netscape Growth 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 Netscape Growth, then the stock price of the Netscape Growth 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 Netscape Growth 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 key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What will be a multi year spillover effect of various taxation regulations.

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.

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.






Negotiation Strategy of Three Strategies for Managing Fast Growth

References & Further Readings

Georg von Krogh, Michael A. Cusumano (2018), "Three Strategies for Managing Fast Growth Harvard Business Review Case Study. Published by HBR Publications.


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