The Impact of Illegal Peer-to-Peer File-Sharing on the Media Industry 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 The Impact of Illegal Peer-to-Peer File-Sharing on the Media Industry case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Impact of Illegal Peer-to-Peer File-Sharing on the Media Industry case study is a Harvard Business School (HBR) case study written by Sanjay Goel, Paul Miesing, Uday Chandra. The The Impact of Illegal Peer-to-Peer File-Sharing on the Media Industry (referred as “Peer Sharing” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Customers, Intellectual property, Internet, Networking.

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 The Impact of Illegal Peer-to-Peer File-Sharing on the Media Industry Case Study

Peer-to-Peer networking technology and related innovations have had a major impact on the music and motion picture industries. While digital technology has improved the quality of audio and video recordings and decreased distribution costs, it has also made unauthorized duplication of copyrighted material and its transmission over the Internet easier. The media industry attributes an erosion of its sales after 1999 to the illegal copying and sharing of digital files and has taken steps to tighten copyright laws and prosecute violators. Others attribute the downturn to a lack of innovative products and futile efforts by the industry to retain a business model made obsolete by technological innovation. In the meantime, unauthorized file-sharing via Peer-to-Peer networks continues unabated and its real financial impact on the industry remains unclear. The market perceives illegal file-sharing to be a significant threat to the long-term profitability of the media industry and regards current legal initiatives to protect its intellectual capital as beneficial. This article discusses several strategies and business models that the media industry may consider to respond to the current threat and better cater to changing customer tastes.

Case Authors : Sanjay Goel, Paul Miesing, Uday Chandra

Topic : Technology & Operations

Related Areas : Customers, Intellectual property, Internet, Networking

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Calculating Net Present Value (NPV) at 6% for The Impact of Illegal Peer-to-Peer File-Sharing on the Media Industry Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10007114)	-10007114	-	-
Year 1	3459105	-6548009	3459105	0.9434	3263307
Year 2	3973928	-2574081	7433033	0.89	3536782
Year 3	3951841	1377760	11384874	0.8396	3318042
Year 4	3244931	4622691	14629805	0.7921	2570289
TOTAL			14629805		12688420

The Net Present Value at 6% discount rate is 2681306

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. Internal Rate of Return
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. Timing of the expected cash flows – stockholders of Peer Sharing 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. Peer Sharing 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 The Impact of Illegal Peer-to-Peer File-Sharing on the Media Industry

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 Peer Sharing 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 Peer Sharing 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	(10007114)	-10007114	-	-
Year 1	3459105	-6548009	3459105	0.8696	3007917
Year 2	3973928	-2574081	7433033	0.7561	3004860
Year 3	3951841	1377760	11384874	0.6575	2598400
Year 4	3244931	4622691	14629805	0.5718	1855300
TOTAL					10466477

The Net NPV after 4 years is 459363

(10466477 - 10007114 )

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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	(10007114)	-10007114	-	-
Year 1	3459105	-6548009	3459105	0.8333	2882588
Year 2	3973928	-2574081	7433033	0.6944	2759672
Year 3	3951841	1377760	11384874	0.5787	2286945
Year 4	3244931	4622691	14629805	0.4823	1564878
TOTAL					9494083

The Net NPV after 4 years is -513031

At 20% discount rate the NPV is negative (9494083 - 10007114 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Peer Sharing 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 Peer Sharing has a NPV value higher than Zero then finance managers at Peer Sharing 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 Peer Sharing, then the stock price of the Peer Sharing 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 Peer Sharing 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 –

Understanding of risks involved in 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 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 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 The Impact of Illegal Peer-to-Peer File-Sharing on the Media Industry

References & Further Readings

Sanjay Goel, Paul Miesing, Uday Chandra (2018), "The Impact of Illegal Peer-to-Peer File-Sharing on the Media Industry Harvard Business Review Case Study. Published by HBR Publications.