Nokia Corp.: Innovation and Efficiency in a High-Growth Global Firm 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 Nokia Corp.: Innovation and Efficiency in a High-Growth Global Firm case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Nokia Corp.: Innovation and Efficiency in a High-Growth Global Firm case study is a Harvard Business School (HBR) case study written by John Roberts, Katherine Doornik. The Nokia Corp.: Innovation and Efficiency in a High-Growth Global Firm (referred as “Nokia Telephony” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Internet, Organizational structure.

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 Nokia Corp.: Innovation and Efficiency in a High-Growth Global Firm Case Study

Nokia Corp. is a global telecommunications company that, in eight years, went from a near-bankrupt conglomerate to a global leader in mobile telephony, delivering almost 30% annual compound growth in revenues during 1992-2000, while shedding businesses that had accounted for almost 90% of its 1998 shares. By spring 2000, Nokia had the highest margins in the mobile phone industry, a negative debt-equity ratio, the most valuable non-U.S. brand in the world, Europe's highest market capitalization, a presence in 140 countries, and unique corporate structures, processes, and culture that gave it the feel of "a small company soul in a big corporate body." Along with growth in size and diversity, however, came growth in complexity. Nokia had to develop multiple businesses and technologies (while dealing with the great technological uncertainties that were inherent in the convergence of mobile telephony and the Internet). It also had to manage a growing network of alliances and a number of acquisitions, mostly in the United States. This case provides the background to the issues Nokia faces as it considers how to meet these challenges while maintaining its unique company values and way of working that made it possible to execute efficiently while continuing to innovate.

Case Authors : John Roberts, Katherine Doornik

Topic : Technology & Operations

Related Areas : Internet, Organizational structure

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Calculating Net Present Value (NPV) at 6% for Nokia Corp.: Innovation and Efficiency in a High-Growth Global Firm Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019852)	-10019852	-	-
Year 1	3450685	-6569167	3450685	0.9434	3255363
Year 2	3978945	-2590222	7429630	0.89	3541247
Year 3	3943535	1353313	11373165	0.8396	3311068
Year 4	3238164	4591477	14611329	0.7921	2564929
TOTAL			14611329		12672607

The Net Present Value at 6% discount rate is 2652755

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. Net Present Value
2. Payback Period
3. Internal Rate of Return
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. Nokia Telephony 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 Nokia Telephony 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 Nokia Corp.: Innovation and Efficiency in a High-Growth Global Firm

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 Nokia Telephony 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 Nokia Telephony 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	(10019852)	-10019852	-	-
Year 1	3450685	-6569167	3450685	0.8696	3000596
Year 2	3978945	-2590222	7429630	0.7561	3008654
Year 3	3943535	1353313	11373165	0.6575	2592938
Year 4	3238164	4591477	14611329	0.5718	1851431
TOTAL					10453619

The Net NPV after 4 years is 433767

(10453619 - 10019852 )

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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	(10019852)	-10019852	-	-
Year 1	3450685	-6569167	3450685	0.8333	2875571
Year 2	3978945	-2590222	7429630	0.6944	2763156
Year 3	3943535	1353313	11373165	0.5787	2282138
Year 4	3238164	4591477	14611329	0.4823	1561615
TOTAL					9482480

The Net NPV after 4 years is -537372

At 20% discount rate the NPV is negative (9482480 - 10019852 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Nokia Telephony 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 Nokia Telephony has a NPV value higher than Zero then finance managers at Nokia Telephony 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 Nokia Telephony, then the stock price of the Nokia Telephony 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 Nokia Telephony 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 can impact the cash flow of the project.

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.

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 Nokia Corp.: Innovation and Efficiency in a High-Growth Global Firm

References & Further Readings

John Roberts, Katherine Doornik (2018), "Nokia Corp.: Innovation and Efficiency in a High-Growth Global Firm Harvard Business Review Case Study. Published by HBR Publications.