Singapore International Airlines: Preparing For Turbulence Ahead 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 Singapore International Airlines: Preparing For Turbulence Ahead case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Singapore International Airlines: Preparing For Turbulence Ahead case study is a Harvard Business School (HBR) case study written by Kannan Ramaswamy. The Singapore International Airlines: Preparing For Turbulence Ahead (referred as “Sia Airlines” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, .

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 Singapore International Airlines: Preparing For Turbulence Ahead Case Study

This is a Thunderbird Case Study.By 2004, Singapore International Airlines (SIA) enjoyed a run of exemplary profitability and service performance. It had built its strategy around the principles of a differentiated positioning using its brand image, geographic location, and outstanding service as the cornerstones of its strategy. The case offers enough data to launch into a rich discussion of the industry factors that drive profitability, and complements it with an in-depth look at the model of strategy that SIA had built in order to compete in the airline business. In recent years, there have been many environmental shocks, such as SARS, that have challenged the continued viability of the model. The company entered into an equity alliance with Virgin that has destroyed significant value. It found itself challenged by the entry of many low-cost airlines in its home market. The case closes with a decision that SIA needed to make about how it would address the onset of low-cost competitors, and whether it would make sense to move away from its differentiated premium approach.

Case Authors : Kannan Ramaswamy

Topic : Strategy & Execution

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Singapore International Airlines: Preparing For Turbulence Ahead Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10015440)	-10015440	-	-
Year 1	3463871	-6551569	3463871	0.9434	3267803
Year 2	3976123	-2575446	7439994	0.89	3538735
Year 3	3961288	1385842	11401282	0.8396	3325974
Year 4	3243019	4628861	14644301	0.7921	2568775
TOTAL			14644301		12701287

The Net Present Value at 6% discount rate is 2685847

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. Profitability Index
3. Payback Period
4. Net Present Value

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Sia Airlines shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Sia Airlines have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Singapore International Airlines: Preparing For Turbulence Ahead

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 Sia Airlines 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 Sia Airlines 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	(10015440)	-10015440	-	-
Year 1	3463871	-6551569	3463871	0.8696	3012062
Year 2	3976123	-2575446	7439994	0.7561	3006520
Year 3	3961288	1385842	11401282	0.6575	2604611
Year 4	3243019	4628861	14644301	0.5718	1854207
TOTAL					10477400

The Net NPV after 4 years is 461960

(10477400 - 10015440 )

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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	(10015440)	-10015440	-	-
Year 1	3463871	-6551569	3463871	0.8333	2886559
Year 2	3976123	-2575446	7439994	0.6944	2761197
Year 3	3961288	1385842	11401282	0.5787	2292412
Year 4	3243019	4628861	14644301	0.4823	1563956
TOTAL					9504124

The Net NPV after 4 years is -511316

At 20% discount rate the NPV is negative (9504124 - 10015440 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Sia Airlines 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 Sia Airlines has a NPV value higher than Zero then finance managers at Sia Airlines 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 Sia Airlines, then the stock price of the Sia Airlines 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 Sia Airlines 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.

Understanding of risks involved in the project.

What can impact the cash flow of 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 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 Singapore International Airlines: Preparing For Turbulence Ahead

References & Further Readings

Kannan Ramaswamy (2018), "Singapore International Airlines: Preparing For Turbulence Ahead Harvard Business Review Case Study. Published by HBR Publications.