BandPage (A) 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 BandPage (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. BandPage (A) case study is a Harvard Business School (HBR) case study written by Karim R. Lakhani, Colin Maclay, Greta Friar. The BandPage (A) (referred as “Bandpage Bandpage's” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Marketing, 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 BandPage (A) Case Study

BandPage CEO James "J" Sider is about to receive results from BandPage's targeted advertising campaign on music streaming service Rhapsody and learn whether BandPage's strategy to improve ad click through rates and generate revenue has succeeded. BandPage, which began as a Facebook app to help musicians build professional-looking pages and convert fan "likes" into revenue, has become a major hub in the online music network. BandPage has deals with upstream and downstream music partners, from streaming services to ticket sellers to merchandise companies, and has built relationships with artists by providing a one stop shop to update current band information across most major music sites simultaneously. BandPage's most recent project has been to differentiate fans by their behavior on streaming sites in order to target super fans with high priced, exclusive and/or personalized offers from artists. At a time when tensions are high between streaming services and artists who believe that they are not being fairly compensated for the use of their music, Sider is convinced that BandPage can help streaming services drive revenue growth for artists through ticket, merchandise and exclusive offer sales. If the Rhapsody data proves that BandPage's strategy is working, the potential revenue growth for BandPage and all of its partners is massive.

Case Authors : Karim R. Lakhani, Colin Maclay, Greta Friar

Topic : Technology & Operations

Related Areas : Marketing, Technology

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Calculating Net Present Value (NPV) at 6% for BandPage (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10006153)	-10006153	-	-
Year 1	3465465	-6540688	3465465	0.9434	3269307
Year 2	3980695	-2559993	7446160	0.89	3542804
Year 3	3975018	1415025	11421178	0.8396	3337502
Year 4	3225501	4640526	14646679	0.7921	2554899
TOTAL			14646679		12704512

The Net Present Value at 6% discount rate is 2698359

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. Internal Rate of Return
3. Payback Period
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. Bandpage Bandpage's 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 Bandpage Bandpage's 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 BandPage (A)

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 Bandpage Bandpage's 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 Bandpage Bandpage's 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	(10006153)	-10006153	-	-
Year 1	3465465	-6540688	3465465	0.8696	3013448
Year 2	3980695	-2559993	7446160	0.7561	3009977
Year 3	3975018	1415025	11421178	0.6575	2613639
Year 4	3225501	4640526	14646679	0.5718	1844191
TOTAL					10481255

The Net NPV after 4 years is 475102

(10481255 - 10006153 )

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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	(10006153)	-10006153	-	-
Year 1	3465465	-6540688	3465465	0.8333	2887888
Year 2	3980695	-2559993	7446160	0.6944	2764372
Year 3	3975018	1415025	11421178	0.5787	2300358
Year 4	3225501	4640526	14646679	0.4823	1555508
TOTAL					9508124

The Net NPV after 4 years is -498029

At 20% discount rate the NPV is negative (9508124 - 10006153 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Bandpage Bandpage's 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 Bandpage Bandpage's has a NPV value higher than Zero then finance managers at Bandpage Bandpage's 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 Bandpage Bandpage's, then the stock price of the Bandpage Bandpage's 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 Bandpage Bandpage's 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 can impact the cash flow of the project.

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

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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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 BandPage (A)

References & Further Readings

Karim R. Lakhani, Colin Maclay, Greta Friar (2018), "BandPage (A) Harvard Business Review Case Study. Published by HBR Publications.