Slouching Toward Broadband: Revisited in 2005 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 Slouching Toward Broadband: Revisited in 2005 case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Slouching Toward Broadband: Revisited in 2005 case study is a Harvard Business School (HBR) case study written by Robert A. Burgelman, Les Vadasz, Philip Meza. The Slouching Toward Broadband: Revisited in 2005 (referred as “Broadband Wired” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Strategy.

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 Slouching Toward Broadband: Revisited in 2005 Case Study

At a time when many things Americans consumed were "supersized," Internet access in the United States was decidedly sparing. Instead of using always-on broadband for Internet access, most Americans accessed the Web through slow dial-up connections. More advanced Internet applications, such as Web phone calls, video-on-demand, or Web broadcasts of music or television, were haltingly slow or completely impractical at nonbroadband speeds. The full benefits of the Internet as a delivery channel for much consumer-targeted advanced e-commerce or entertainment applications would have to wait until broadband became ubiquitous. In contrast to the United States, many other countries were making broadband penetration a national priority, and their citizens were fast becoming more wired than those in the United States. What, if anything, could incumbent local exchange carriers or cable companies do to help shape their futures and speed the consumer adoption of broadband? Was that really in their interests? Ubiquitous broadband was certainly in the interests of companies such as Intel, Microsoft, and EarthLink. What could they do to catalyze the arrival of consumer broadband? What, if anything, should the United States government do to make its citizens more wired? What were the forces involved in broadband in the United States and how did they influence its deployment? In turn, could companies and industries influence those forces to their own advantage?

Case Authors : Robert A. Burgelman, Les Vadasz, Philip Meza

Topic : Technology & Operations

Related Areas : Strategy

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Calculating Net Present Value (NPV) at 6% for Slouching Toward Broadband: Revisited in 2005 Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10006204)	-10006204	-	-
Year 1	3451110	-6555094	3451110	0.9434	3255764
Year 2	3975553	-2579541	7426663	0.89	3538228
Year 3	3964822	1385281	11391485	0.8396	3328941
Year 4	3245800	4631081	14637285	0.7921	2570978
TOTAL			14637285		12693911

The Net Present Value at 6% discount rate is 2687707

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 Broadband Wired 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. Broadband Wired 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 Slouching Toward Broadband: Revisited in 2005

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 Broadband Wired 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 Broadband Wired 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	(10006204)	-10006204	-	-
Year 1	3451110	-6555094	3451110	0.8696	3000965
Year 2	3975553	-2579541	7426663	0.7561	3006089
Year 3	3964822	1385281	11391485	0.6575	2606935
Year 4	3245800	4631081	14637285	0.5718	1855797
TOTAL					10469786

The Net NPV after 4 years is 463582

(10469786 - 10006204 )

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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	(10006204)	-10006204	-	-
Year 1	3451110	-6555094	3451110	0.8333	2875925
Year 2	3975553	-2579541	7426663	0.6944	2760801
Year 3	3964822	1385281	11391485	0.5787	2294457
Year 4	3245800	4631081	14637285	0.4823	1565297
TOTAL					9496480

The Net NPV after 4 years is -509724

At 20% discount rate the NPV is negative (9496480 - 10006204 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Broadband Wired 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 Broadband Wired has a NPV value higher than Zero then finance managers at Broadband Wired 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 Broadband Wired, then the stock price of the Broadband Wired 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 Broadband Wired 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 can impact the cash flow of 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.

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 Slouching Toward Broadband: Revisited in 2005

References & Further Readings

Robert A. Burgelman, Les Vadasz, Philip Meza (2018), "Slouching Toward Broadband: Revisited in 2005 Harvard Business Review Case Study. Published by HBR Publications.