Making RFID Work: The World's Largest University Library RFID Implementation 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 Making RFID Work: The World's Largest University Library RFID Implementation case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Making RFID Work: The World's Largest University Library RFID Implementation case study is a Harvard Business School (HBR) case study written by Benjamin Yen, Boby Shiu. The Making RFID Work: The World's Largest University Library RFID Implementation (referred as “Rfid Libraries” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Innovation, IT, Project management, Supply chain.

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 Making RFID Work: The World's Largest University Library RFID Implementation Case Study

In October 2008, the University of Hong Kong's Libraries ("HKU Libraries") successfully launched an initiative to introduce radio-frequency identification ("RFID") into its Main Library. Through the RFID initiative, HKU Libraries intended to pursue effective management of the public and private resources bestowed upon the institution. In 2008, the libraries served a total of 102,676 registered borrowers and had collected a total of 2.65 million items. Managing such a large number of resources was always an issue for HKU Libraries' management team. Deputy Librarian Peter Sidorko saw the promise of RFID technology in helping him to serve the libraries and their users better. After reviewing the possible use of RFID, HKU Libraries chose the Main Library, one of seven branches, as the first location for launching the RFID initiative. The 2008 launch was the first phase in the RFID implementation scheme. Although initial RFID usage information had not been compiled, Sidorko had to decide what the next step of this initiative should be. What should Sidorko consider when implementing future RFID strategies?

Case Authors : Benjamin Yen, Boby Shiu

Topic : Technology & Operations

Related Areas : Innovation, IT, Project management, Supply chain

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Calculating Net Present Value (NPV) at 6% for Making RFID Work: The World's Largest University Library RFID Implementation Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10026522)	-10026522	-	-
Year 1	3460249	-6566273	3460249	0.9434	3264386
Year 2	3976292	-2589981	7436541	0.89	3538886
Year 3	3969338	1379357	11405879	0.8396	3332733
Year 4	3246111	4625468	14651990	0.7921	2571224
TOTAL			14651990		12707228

The Net Present Value at 6% discount rate is 2680706

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. Profitability Index
2. Payback Period
3. Net Present Value
4. Internal Rate of Return

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 Rfid Libraries 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. Rfid Libraries 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 Making RFID Work: The World's Largest University Library RFID Implementation

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 Technology & Operations 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 Rfid Libraries 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 Rfid Libraries 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	(10026522)	-10026522	-	-
Year 1	3460249	-6566273	3460249	0.8696	3008912
Year 2	3976292	-2589981	7436541	0.7561	3006648
Year 3	3969338	1379357	11405879	0.6575	2609904
Year 4	3246111	4625468	14651990	0.5718	1855974
TOTAL					10481439

The Net NPV after 4 years is 454917

(10481439 - 10026522 )

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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	(10026522)	-10026522	-	-
Year 1	3460249	-6566273	3460249	0.8333	2883541
Year 2	3976292	-2589981	7436541	0.6944	2761314
Year 3	3969338	1379357	11405879	0.5787	2297071
Year 4	3246111	4625468	14651990	0.4823	1565447
TOTAL					9507372

The Net NPV after 4 years is -519150

At 20% discount rate the NPV is negative (9507372 - 10026522 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Rfid Libraries 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 Rfid Libraries has a NPV value higher than Zero then finance managers at Rfid Libraries 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 Rfid Libraries, then the stock price of the Rfid Libraries 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 Rfid Libraries 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 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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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 Making RFID Work: The World's Largest University Library RFID Implementation

References & Further Readings

Benjamin Yen, Boby Shiu (2018), "Making RFID Work: The World's Largest University Library RFID Implementation Harvard Business Review Case Study. Published by HBR Publications.