Leveraging Internet Technologies in B2B Relationships 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 Leveraging Internet Technologies in B2B Relationships case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Leveraging Internet Technologies in B2B Relationships case study is a Harvard Business School (HBR) case study written by Sandy Jap, Jakki J. Mohr. The Leveraging Internet Technologies in B2B Relationships (referred as “Technologies Internet” 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.

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 Leveraging Internet Technologies in B2B Relationships Case Study

Why is it that two firms can use the Internet in the same way (e.g., to reach new customers) and achieve very different outcomes? How can firms better allocate and subsequently leverage the investments they make in Internet technologies? This article shows that e-commerce technologies cannot be successfully leveraged without considering the organizational relationships in which the technologies are being embedded. By properly matching the B2B context with Internet technologies, firms can be in a better position not only to achieve significant economic outcomes, but also to attain sustainable competitive advantages, improve coordination and collaboration processes, and decrease channel resistance.

Case Authors : Sandy Jap, Jakki J. Mohr

Topic : Technology & Operations

Related Areas : Internet

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Calculating Net Present Value (NPV) at 6% for Leveraging Internet Technologies in B2B Relationships Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016284)	-10016284	-	-
Year 1	3467454	-6548830	3467454	0.9434	3271183
Year 2	3968979	-2579851	7436433	0.89	3532377
Year 3	3967914	1388063	11404347	0.8396	3331537
Year 4	3228363	4616426	14632710	0.7921	2557166
TOTAL			14632710		12692263

The Net Present Value at 6% discount rate is 2675979

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. Internal Rate of Return
3. Payback Period
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. Timing of the expected cash flows – stockholders of Technologies Internet 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. Technologies Internet 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 Leveraging Internet Technologies in B2B Relationships

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 Technologies Internet 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 Technologies Internet 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	(10016284)	-10016284	-	-
Year 1	3467454	-6548830	3467454	0.8696	3015177
Year 2	3968979	-2579851	7436433	0.7561	3001118
Year 3	3967914	1388063	11404347	0.6575	2608968
Year 4	3228363	4616426	14632710	0.5718	1845827
TOTAL					10471091

The Net NPV after 4 years is 454807

(10471091 - 10016284 )

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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	(10016284)	-10016284	-	-
Year 1	3467454	-6548830	3467454	0.8333	2889545
Year 2	3968979	-2579851	7436433	0.6944	2756235
Year 3	3967914	1388063	11404347	0.5787	2296247
Year 4	3228363	4616426	14632710	0.4823	1556888
TOTAL					9498915

The Net NPV after 4 years is -517369

At 20% discount rate the NPV is negative (9498915 - 10016284 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Technologies Internet 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 Technologies Internet has a NPV value higher than Zero then finance managers at Technologies Internet 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 Technologies Internet, then the stock price of the Technologies Internet 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 Technologies Internet 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 will be a multi year spillover effect of various taxation regulations.

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.

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.

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 Leveraging Internet Technologies in B2B Relationships

References & Further Readings

Sandy Jap, Jakki J. Mohr (2018), "Leveraging Internet Technologies in B2B Relationships Harvard Business Review Case Study. Published by HBR Publications.