Scientific Glass Incorporated: Inventory Management (Brief Case) 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 Scientific Glass Incorporated: Inventory Management (Brief Case) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Scientific Glass Incorporated: Inventory Management (Brief Case) case study is a Harvard Business School (HBR) case study written by Steven C. Wheelwright, William Schmidt. The Scientific Glass Incorporated: Inventory Management (Brief Case) (referred as “Inventory Glassware” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Financial management, Sales, Technology.

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 Scientific Glass Incorporated: Inventory Management (Brief Case) Case Study

When students have the English-language PDF of this Brief Case in a coursepack, they will also have the option to purchase an audio version.Scientific Glassware is a fast-growing, privately held company that provides specialized glassware for laboratory and research facilities. Excess inventory is tying up extra capital needed to fund the company's expansion plans. The newly hired Manager of Inventory Planning is tasked with developing an effective strategy for managing inventory without requiring additional capital investment. The company has launched several initiatives, such as adding a dedicated domestic sales force, which directly affect inventory requirements. At the same time, the company has announced a commitment to improve customer responsiveness and reduce the "fill rate," the time it takes to fulfill new orders. These changes may require adding warehouses or outsourcing fulfillment services. This case focuses on the business challenges of inventory control and order processing, particularly the tradeoffs between centralized and decentralized inventories. Students must complete a quantitative analysis of the costs and benefits of several alternatives. Subjects Include: logistics, inventory control, order processing, inventory management, fulfillment, warehouses, and materials management.

Case Authors : Steven C. Wheelwright, William Schmidt

Topic : Technology & Operations

Related Areas : Financial management, Sales, Technology

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Calculating Net Present Value (NPV) at 6% for Scientific Glass Incorporated: Inventory Management (Brief Case) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10006925)	-10006925	-	-
Year 1	3451754	-6555171	3451754	0.9434	3256372
Year 2	3958432	-2596739	7410186	0.89	3522990
Year 3	3959211	1362472	11369397	0.8396	3324230
Year 4	3241749	4604221	14611146	0.7921	2567769
TOTAL			14611146		12671361

The Net Present Value at 6% discount rate is 2664436

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. Net Present Value
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. Timing of the expected cash flows – stockholders of Inventory Glassware 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. Inventory Glassware 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 Scientific Glass Incorporated: Inventory Management (Brief Case)

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 Inventory Glassware 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 Inventory Glassware 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	(10006925)	-10006925	-	-
Year 1	3451754	-6555171	3451754	0.8696	3001525
Year 2	3958432	-2596739	7410186	0.7561	2993143
Year 3	3959211	1362472	11369397	0.6575	2603246
Year 4	3241749	4604221	14611146	0.5718	1853481
TOTAL					10451395

The Net NPV after 4 years is 444470

(10451395 - 10006925 )

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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	(10006925)	-10006925	-	-
Year 1	3451754	-6555171	3451754	0.8333	2876462
Year 2	3958432	-2596739	7410186	0.6944	2748911
Year 3	3959211	1362472	11369397	0.5787	2291210
Year 4	3241749	4604221	14611146	0.4823	1563343
TOTAL					9479926

The Net NPV after 4 years is -526999

At 20% discount rate the NPV is negative (9479926 - 10006925 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Inventory Glassware 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 Inventory Glassware has a NPV value higher than Zero then finance managers at Inventory Glassware 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 Inventory Glassware, then the stock price of the Inventory Glassware 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 Inventory Glassware 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 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.

Understanding of risks involved in the project.

What can impact the cash flow of the project.

What will be a multi year spillover effect of various taxation regulations.

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 Scientific Glass Incorporated: Inventory Management (Brief Case)

References & Further Readings

Steven C. Wheelwright, William Schmidt (2018), "Scientific Glass Incorporated: Inventory Management (Brief Case) Harvard Business Review Case Study. Published by HBR Publications.