Taiwan Semiconductor Manufacturing Co.: The Semiconductor Services Company 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 Taiwan Semiconductor Manufacturing Co.: The Semiconductor Services Company case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Taiwan Semiconductor Manufacturing Co.: The Semiconductor Services Company case study is a Harvard Business School (HBR) case study written by Hau Lee, Seungjin Whang, Shiri Shneorson. The Taiwan Semiconductor Manufacturing Co.: The Semiconductor Services Company (referred as “Semiconductor Tsmc” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Customer service, Globalization, IT, Marketing, Strategic planning, 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 Taiwan Semiconductor Manufacturing Co.: The Semiconductor Services Company Case Study

Founded in 1987, Taiwan Semiconductor Manufacturing Co. (TSMC) was the world's first pure foundry, focused solely on the manufacturing of semiconductors. Operating in the cyclical semiconductor market, the company managed to grow rapidly and to become the world's 8th largest semiconductor manufacturer with more than a 50% market share in the foundry business. In the company's early days, TSMC management focused on manufacturing excellence and technology leadership. As competition in the sector intensified in the late 1990s, the company began to focus on customer service to differentiate itself further from companies like UMC, its next-door neighbor and closest competitor, and the rapidly growing Chinese foundries. The company invested heavily in the development of innovative, value-added services and proprietary information systems that would facilitate better communication and improve customer service, putting in place eCommerce applications such as eFoundry and Enterprise Supply Chain Management suites. TSMC management believed that customers, typically U.S.-based integrated circuit design houses facing high financial stakes, rapid technological innovations, short product life cycles, and intensive competition, would choose a foundry business partner based on quality, trustworthiness, and reputation, as opposed to price only. Could superior customer service make an impact in a capital-intensive, process- and quality- oriented industry such as the semiconductor industry, or would TSMC have to compete on price? Explores these issues, as well as other factors affecting TSMC's strategic path as it moves forward in the mid-2000s.

Case Authors : Hau Lee, Seungjin Whang, Shiri Shneorson

Topic : Technology & Operations

Related Areas : Customer service, Globalization, IT, Marketing, Strategic planning, Supply chain

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Calculating Net Present Value (NPV) at 6% for Taiwan Semiconductor Manufacturing Co.: The Semiconductor Services Company Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10024603)	-10024603	-	-
Year 1	3452706	-6571897	3452706	0.9434	3257270
Year 2	3969692	-2602205	7422398	0.89	3533012
Year 3	3967419	1365214	11389817	0.8396	3331121
Year 4	3238956	4604170	14628773	0.7921	2565557
TOTAL			14628773		12686960

The Net Present Value at 6% discount rate is 2662357

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. Payback Period
2. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Semiconductor Tsmc 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 Semiconductor Tsmc 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 Taiwan Semiconductor Manufacturing Co.: The Semiconductor Services Company

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 Semiconductor Tsmc 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 Semiconductor Tsmc 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	(10024603)	-10024603	-	-
Year 1	3452706	-6571897	3452706	0.8696	3002353
Year 2	3969692	-2602205	7422398	0.7561	3001657
Year 3	3967419	1365214	11389817	0.6575	2608642
Year 4	3238956	4604170	14628773	0.5718	1851884
TOTAL					10464537

The Net NPV after 4 years is 439934

(10464537 - 10024603 )

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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	(10024603)	-10024603	-	-
Year 1	3452706	-6571897	3452706	0.8333	2877255
Year 2	3969692	-2602205	7422398	0.6944	2756731
Year 3	3967419	1365214	11389817	0.5787	2295960
Year 4	3238956	4604170	14628773	0.4823	1561997
TOTAL					9491942

The Net NPV after 4 years is -532661

At 20% discount rate the NPV is negative (9491942 - 10024603 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Semiconductor Tsmc 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 Semiconductor Tsmc has a NPV value higher than Zero then finance managers at Semiconductor Tsmc 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 Semiconductor Tsmc, then the stock price of the Semiconductor Tsmc 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 Semiconductor Tsmc 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 can impact the cash flow of 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.

Understanding of risks involved in 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 Taiwan Semiconductor Manufacturing Co.: The Semiconductor Services Company

References & Further Readings

Hau Lee, Seungjin Whang, Shiri Shneorson (2018), "Taiwan Semiconductor Manufacturing Co.: The Semiconductor Services Company Harvard Business Review Case Study. Published by HBR Publications.