MedNet.com Confronts 'Click-Through' Competition, Portuguese Version 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 MedNet.com Confronts 'Click-Through' Competition, Portuguese Version case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. MedNet.com Confronts 'Click-Through' Competition, Portuguese Version case study is a Harvard Business School (HBR) case study written by Allegra Young. The MedNet.com Confronts 'Click-Through' Competition, Portuguese Version (referred as “Mednet Sites” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Financial management, Internet, Marketing.

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 MedNet.com Confronts 'Click-Through' Competition, Portuguese Version Case Study

When students have the English-language PDF of this Brief Case in a coursepack, they will also have the option to purchase an audio version.In January 2007, "MedNet.com" is a leading website that provides science-based health information free of charge to online visitors. MedNet communicates with traditional web journalism, interactive software, and social media tools such as blogs, video reports and virtual reality tours. The site operates conservatively within the government-regulated health information market. MedNet's business model relies on advertising sales, primarily to pharmaceutical companies. MedNet competes for advertising dollars with large search engines, category specific sites, and clinical trial sites. In 2007, large search engines charge for "results," or "click throughs." Other sites, such as online newspapers, charge for impressions. Advertising campaigns depend on numerous variables (an efficient audience size, audience frame of mind, willingness to complete a transaction, etc.) In the face of fierce advertising competition, MedNet is forced to defend key elements of its business model vis-a-vis a large search engine. However, in defending the advertising value MedNet delivers, MedNet executives may be building the case for why niche sites may be a better investment for the advertiser's budget.

Case Authors : Allegra Young

Topic : Strategy & Execution

Related Areas : Financial management, Internet, Marketing

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Calculating Net Present Value (NPV) at 6% for MedNet.com Confronts 'Click-Through' Competition, Portuguese Version Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10023177)	-10023177	-	-
Year 1	3471226	-6551951	3471226	0.9434	3274742
Year 2	3967302	-2584649	7438528	0.89	3530885
Year 3	3950108	1365459	11388636	0.8396	3316587
Year 4	3231348	4596807	14619984	0.7921	2559530
TOTAL			14619984		12681743

The Net Present Value at 6% discount rate is 2658566

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. Internal Rate of Return
2. Payback Period
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 Mednet Sites 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. Mednet Sites 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 MedNet.com Confronts 'Click-Through' Competition, Portuguese Version

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 Mednet Sites 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 Mednet Sites 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	(10023177)	-10023177	-	-
Year 1	3471226	-6551951	3471226	0.8696	3018457
Year 2	3967302	-2584649	7438528	0.7561	2999850
Year 3	3950108	1365459	11388636	0.6575	2597260
Year 4	3231348	4596807	14619984	0.5718	1847534
TOTAL					10463102

The Net NPV after 4 years is 439925

(10463102 - 10023177 )

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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	(10023177)	-10023177	-	-
Year 1	3471226	-6551951	3471226	0.8333	2892688
Year 2	3967302	-2584649	7438528	0.6944	2755071
Year 3	3950108	1365459	11388636	0.5787	2285942
Year 4	3231348	4596807	14619984	0.4823	1558328
TOTAL					9492029

The Net NPV after 4 years is -531148

At 20% discount rate the NPV is negative (9492029 - 10023177 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Mednet Sites 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 Mednet Sites has a NPV value higher than Zero then finance managers at Mednet Sites 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 Mednet Sites, then the stock price of the Mednet Sites 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 Mednet Sites 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 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 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 MedNet.com Confronts 'Click-Through' Competition, Portuguese Version

References & Further Readings

Allegra Young (2018), "MedNet.com Confronts 'Click-Through' Competition, Portuguese Version Harvard Business Review Case Study. Published by HBR Publications.