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STEELSCREEN.com: Why IT is Not Everywhere in B2B and the Role of the CEO in 'IT' 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 STEELSCREEN.com: Why IT is Not Everywhere in B2B and the Role of the CEO in 'IT' case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. STEELSCREEN.com: Why IT is Not Everywhere in B2B and the Role of the CEO in 'IT' case study is a Harvard Business School (HBR) case study written by Brian Subirana. The STEELSCREEN.com: Why IT is Not Everywhere in B2B and the Role of the CEO in 'IT' (referred as “Session Technology” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Leadership.

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 STEELSCREEN.com: Why IT is Not Everywhere in B2B and the Role of the CEO in 'IT' Case Study


This case is intended to serve as the basis for one or two sessions of an introductory Information Technology course at an MBA program or for one session at a senior executive program. The aim is to address what needs to be known by general managers in terms of technology and at the same time serve as an introduction for those who want to deepen their knowledge in business-to-business (B2B) technologies. Thus, it is intended to cover basic technology principles and concepts essential for any CEO/MBA. It also covers key business concepts that are impacted by information technology such as industry convergence and B2B. The approach we suggest be taken with this case is an integrative one where both technology and business concepts are intermingled throughout the class discussion. An essential ingredient of this approach is to provide a business rational for why technology matters - using this case in the first session before drilling-down into the more specific technology details of XML and metadata in a possible second session. We have worked on other cases to extend this approach to a full-scale introductory MBA/senior executive class. There are two unique features of this approach. First, it is neither technology centric nor business centric. Instead, it links executive decisions with solid information technology fundamentals. Second, our approach would be concise not requiring more than 200 pages of core case material for a full 25-session course. We believe this is an important feature because MBA-style audience base does not go into a CIO career path most of the times and will therefore not be able to afford the amount of time a longer approach would require.


Case Authors : Brian Subirana

Topic : Technology & Operations

Related Areas : Leadership




Calculating Net Present Value (NPV) at 6% for STEELSCREEN.com: Why IT is Not Everywhere in B2B and the Role of the CEO in 'IT' Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10021398) -10021398 - -
Year 1 3462424 -6558974 3462424 0.9434 3266438
Year 2 3958996 -2599978 7421420 0.89 3523492
Year 3 3968493 1368515 11389913 0.8396 3332023
Year 4 3241536 4610051 14631449 0.7921 2567600
TOTAL 14631449 12689553




The Net Present Value at 6% discount rate is 2668155

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. Payback Period
2. Net Present Value
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. Timing of the expected cash flows – stockholders of Session Technology 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. Session Technology 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 STEELSCREEN.com: Why IT is Not Everywhere in B2B and the Role of the CEO in 'IT'

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 Session Technology 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 Session Technology 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 (10021398) -10021398 - -
Year 1 3462424 -6558974 3462424 0.8696 3010803
Year 2 3958996 -2599978 7421420 0.7561 2993570
Year 3 3968493 1368515 11389913 0.6575 2609349
Year 4 3241536 4610051 14631449 0.5718 1853359
TOTAL 10467081


The Net NPV after 4 years is 445683

(10467081 - 10021398 )








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 (10021398) -10021398 - -
Year 1 3462424 -6558974 3462424 0.8333 2885353
Year 2 3958996 -2599978 7421420 0.6944 2749303
Year 3 3968493 1368515 11389913 0.5787 2296582
Year 4 3241536 4610051 14631449 0.4823 1563241
TOTAL 9494478


The Net NPV after 4 years is -526920

At 20% discount rate the NPV is negative (9494478 - 10021398 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Session Technology 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 Session Technology has a NPV value higher than Zero then finance managers at Session Technology 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 Session Technology, then the stock price of the Session Technology 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 Session Technology 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.






Negotiation Strategy of STEELSCREEN.com: Why IT is Not Everywhere in B2B and the Role of the CEO in 'IT'

References & Further Readings

Brian Subirana (2018), "STEELSCREEN.com: Why IT is Not Everywhere in B2B and the Role of the CEO in 'IT' Harvard Business Review Case Study. Published by HBR Publications.


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