Peer-to-Peer File Sharing and the Market for Digital Information Goods, Spanish 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 Peer-to-Peer File Sharing and the Market for Digital Information Goods, Spanish Version case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Peer-to-Peer File Sharing and the Market for Digital Information Goods, Spanish Version case study is a Harvard Business School (HBR) case study written by Ramon Casadesus-Masanell, Andres Hervas, Jordan Mitchell. The Peer-to-Peer File Sharing and the Market for Digital Information Goods, Spanish Version (referred as “P2p Peer” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Business models, Competition, Internet, Networking, Regulation.

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 Peer-to-Peer File Sharing and the Market for Digital Information Goods, Spanish Version Case Study

To maximize their effectiveness, color cases should be printed in color.As of 2005, over 10 million people were using peer-to-peer (P2P) file-sharing networks to swap music, movies, and software for free. P2P software programs such as Kazaa, Limewire, and eDonkey received a great deal of media attention. Music and movie industry organizations believed that downloading copyrighted material was stealing. The same industry associations took the P2P companies to court, maintaining that the P2P software developers should be held responsible when users unlawfully copied copyrighted songs, movies, and television programs. P2P software creators claimed that they were merely promoting a technology with multiple uses. Indeed, P2P was a network architecture that could be deployed to a number of other applications, such as distributed computing, instant messaging, voice telephony, spam filtering, and other commercial activities. In the midst of high-profile battles between the entertainment industry and P2P file-sharing software developers, a number of proprietary systems offering legal downloads had emerged. Entertainment industry supporters pointed to Apple's iTunes .99 cent download fee per song as an indicator of the future. Although iTunes satisfied entertainment industry executives that it was possible to pay for downloads successfully, the battle between proprietary systems and P2P file sharing seemed to continue. Who would win in the long run? Includes color exhibits.

Case Authors : Ramon Casadesus-Masanell, Andres Hervas, Jordan Mitchell

Topic : Strategy & Execution

Related Areas : Business models, Competition, Internet, Networking, Regulation

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Calculating Net Present Value (NPV) at 6% for Peer-to-Peer File Sharing and the Market for Digital Information Goods, Spanish Version Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10010045)	-10010045	-	-
Year 1	3459565	-6550480	3459565	0.9434	3263741
Year 2	3974184	-2576296	7433749	0.89	3537010
Year 3	3953107	1376811	11386856	0.8396	3319105
Year 4	3224599	4601410	14611455	0.7921	2554184
TOTAL			14611455		12674039

The Net Present Value at 6% discount rate is 2663994

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. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. P2p Peer 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 P2p Peer 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 Peer-to-Peer File Sharing and the Market for Digital Information Goods, Spanish 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 P2p Peer 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 P2p Peer 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	(10010045)	-10010045	-	-
Year 1	3459565	-6550480	3459565	0.8696	3008317
Year 2	3974184	-2576296	7433749	0.7561	3005054
Year 3	3953107	1376811	11386856	0.6575	2599232
Year 4	3224599	4601410	14611455	0.5718	1843675
TOTAL					10456278

The Net NPV after 4 years is 446233

(10456278 - 10010045 )

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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	(10010045)	-10010045	-	-
Year 1	3459565	-6550480	3459565	0.8333	2882971
Year 2	3974184	-2576296	7433749	0.6944	2759850
Year 3	3953107	1376811	11386856	0.5787	2287678
Year 4	3224599	4601410	14611455	0.4823	1555073
TOTAL					9485571

The Net NPV after 4 years is -524474

At 20% discount rate the NPV is negative (9485571 - 10010045 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of P2p Peer 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 P2p Peer has a NPV value higher than Zero then finance managers at P2p Peer 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 P2p Peer, then the stock price of the P2p Peer 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 P2p Peer 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 can impact the cash flow of the project.

Understanding of risks involved in 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.

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.

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 Peer-to-Peer File Sharing and the Market for Digital Information Goods, Spanish Version

References & Further Readings

Ramon Casadesus-Masanell, Andres Hervas, Jordan Mitchell (2018), "Peer-to-Peer File Sharing and the Market for Digital Information Goods, Spanish Version Harvard Business Review Case Study. Published by HBR Publications.