×




Taking on the Challenge of IT Management in a Global Business Context: The Alcan Case - Part 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 Taking on the Challenge of IT Management in a Global Business Context: The Alcan Case - Part A case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Taking on the Challenge of IT Management in a Global Business Context: The Alcan Case - Part A case study is a Harvard Business School (HBR) case study written by Line Dube, Carmen Bernier, Vital Roy. The Taking on the Challenge of IT Management in a Global Business Context: The Alcan Case - Part A (referred as “Alcan Management” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Operations management, 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






Case Description of Taking on the Challenge of IT Management in a Global Business Context: The Alcan Case - Part A Case Study


This case describes the evolution of IT management at Alcan during the period from 2006-2007. At that time, IT governance and the IT function itself were undergoing a complete transformation. The case follows the Vice-President of Corporate Information Technology from the time of his arrival at Alcan: his observations on the current state of IT management, his appointment to the position of Chief Information Officer and the development of his new strategic plan for IT management. Part A presents the main features and challenges of IT management at Alcan up until the middle of 2006. Part B continues with the main concepts and elements of the CIO's new strategic plan for IT management. Students are encouraged to reflect on the characteristics, implications and challenges represented by IT management in a large global organization.


Case Authors : Line Dube, Carmen Bernier, Vital Roy

Topic : Technology & Operations

Related Areas : Operations management, Strategy




Calculating Net Present Value (NPV) at 6% for Taking on the Challenge of IT Management in a Global Business Context: The Alcan Case - Part A Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10026416) -10026416 - -
Year 1 3472535 -6553881 3472535 0.9434 3275976
Year 2 3963601 -2590280 7436136 0.89 3527591
Year 3 3966935 1376655 11403071 0.8396 3330715
Year 4 3245640 4622295 14648711 0.7921 2570851
TOTAL 14648711 12705133




The Net Present Value at 6% discount rate is 2678717

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.




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 Alcan Management 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. Alcan Management shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of Taking on the Challenge of IT Management in a Global Business Context: The Alcan Case - Part 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 Alcan Management 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 Alcan Management 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 (10026416) -10026416 - -
Year 1 3472535 -6553881 3472535 0.8696 3019596
Year 2 3963601 -2590280 7436136 0.7561 2997052
Year 3 3966935 1376655 11403071 0.6575 2608324
Year 4 3245640 4622295 14648711 0.5718 1855705
TOTAL 10480677


The Net NPV after 4 years is 454261

(10480677 - 10026416 )








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 (10026416) -10026416 - -
Year 1 3472535 -6553881 3472535 0.8333 2893779
Year 2 3963601 -2590280 7436136 0.6944 2752501
Year 3 3966935 1376655 11403071 0.5787 2295680
Year 4 3245640 4622295 14648711 0.4823 1565220
TOTAL 9507180


The Net NPV after 4 years is -519236

At 20% discount rate the NPV is negative (9507180 - 10026416 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Alcan Management 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 Alcan Management has a NPV value higher than Zero then finance managers at Alcan Management 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 Alcan Management, then the stock price of the Alcan Management 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 Alcan Management 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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 can impact the cash flow of 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.






Negotiation Strategy of Taking on the Challenge of IT Management in a Global Business Context: The Alcan Case - Part A

References & Further Readings

Line Dube, Carmen Bernier, Vital Roy (2018), "Taking on the Challenge of IT Management in a Global Business Context: The Alcan Case - Part A Harvard Business Review Case Study. Published by HBR Publications.


Apac Citra Centertex SWOT Analysis / TOWS Matrix

Consumer Cyclical , Apparel/Accessories


NTT Docomo, Inc. SWOT Analysis / TOWS Matrix

Services , Communications Services


Capitol Investment IV SWOT Analysis / TOWS Matrix

Financial , Misc. Financial Services


Abbott Labs SWOT Analysis / TOWS Matrix

Healthcare , Medical Equipment & Supplies


Globe International Ltd SWOT Analysis / TOWS Matrix

Consumer Cyclical , Apparel/Accessories


Genel SWOT Analysis / TOWS Matrix

Energy , Oil & Gas Operations


Invt Elec A SWOT Analysis / TOWS Matrix

Technology , Electronic Instr. & Controls


Intl Automated Sys SWOT Analysis / TOWS Matrix

Capital Goods , Misc. Capital Goods


Tecon Animal A SWOT Analysis / TOWS Matrix

Consumer/Non-Cyclical , Food Processing


Intrance SWOT Analysis / TOWS Matrix

Services , Real Estate Operations


Ocean Wilsons Holdings Ltd SWOT Analysis / TOWS Matrix

Transportation , Misc. Transportation