Novo Nordisk A/S: Designing for Diabetics 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 Novo Nordisk A/S: Designing for Diabetics case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Novo Nordisk A/S: Designing for Diabetics case study is a Harvard Business School (HBR) case study written by Karen J. Freeze. The Novo Nordisk A/S: Designing for Diabetics (referred as “Insulin Diabetics” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Manufacturing, Marketing, Product development, Sustainability.

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 Novo Nordisk A/S: Designing for Diabetics Case Study

Novo Nordisk, a Danish company, is the largest supplier of insulin in the world. Using both in-house and outside design services, it has integrated medical research, user-information, and new technologies in team-based projects that have resulted in user-friendly insulin delivery systems, such as insulin pens. These pens have been very successful in Europe and have met varying success elsewhere. The company needs to determine whether its products represent "global design." If not, then how could they? Should they? This case focuses on the use of design in positioning and marketing in the United States an innovative, prefilled, disposable, easy-to-use, pen-like syringe to replace the "drugstore" diabetics conventionally carry. Students are asked to develop a marketing strategy and launch plan to suit local conditions.

Case Authors : Karen J. Freeze

Topic : Technology & Operations

Related Areas : Manufacturing, Marketing, Product development, Sustainability

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Calculating Net Present Value (NPV) at 6% for Novo Nordisk A/S: Designing for Diabetics Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10017843)	-10017843	-	-
Year 1	3460030	-6557813	3460030	0.9434	3264179
Year 2	3963459	-2594354	7423489	0.89	3527464
Year 3	3956161	1361807	11379650	0.8396	3321669
Year 4	3222837	4584644	14602487	0.7921	2552789
TOTAL			14602487		12666101

The Net Present Value at 6% discount rate is 2648258

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Insulin Diabetics 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 Insulin Diabetics 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 Novo Nordisk A/S: Designing for Diabetics

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 Insulin Diabetics 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 Insulin Diabetics 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	(10017843)	-10017843	-	-
Year 1	3460030	-6557813	3460030	0.8696	3008722
Year 2	3963459	-2594354	7423489	0.7561	2996944
Year 3	3956161	1361807	11379650	0.6575	2601240
Year 4	3222837	4584644	14602487	0.5718	1842668
TOTAL					10449574

The Net NPV after 4 years is 431731

(10449574 - 10017843 )

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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	(10017843)	-10017843	-	-
Year 1	3460030	-6557813	3460030	0.8333	2883358
Year 2	3963459	-2594354	7423489	0.6944	2752402
Year 3	3956161	1361807	11379650	0.5787	2289445
Year 4	3222837	4584644	14602487	0.4823	1554223
TOTAL					9479429

The Net NPV after 4 years is -538414

At 20% discount rate the NPV is negative (9479429 - 10017843 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Insulin Diabetics 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 Insulin Diabetics has a NPV value higher than Zero then finance managers at Insulin Diabetics 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 Insulin Diabetics, then the stock price of the Insulin Diabetics 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 Insulin Diabetics 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 Novo Nordisk A/S: Designing for Diabetics

References & Further Readings

Karen J. Freeze (2018), "Novo Nordisk A/S: Designing for Diabetics Harvard Business Review Case Study. Published by HBR Publications.