Driving Innovation at PAR Springer-Miller (B) 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 Driving Innovation at PAR Springer-Miller (B) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Driving Innovation at PAR Springer-Miller (B) case study is a Harvard Business School (HBR) case study written by Susan Fleming, Alyssa W. Goldman. The Driving Innovation at PAR Springer-Miller (B) (referred as “Legacy Springer” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Innovation, Organizational culture, 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 Driving Innovation at PAR Springer-Miller (B) Case Study

In fall 2009, the new president and chief executive officer of PAR Springer-Miller Systems, based in Stowe, Vermont, is tasked with leading the most significant innovation effort the company has undertaken since its founding in 1984. The company is a leading provider of property management, point-of-sale and spa management systems for high-end hotels, resorts, spas and casinos worldwide, but its legacy products are based on outdated technology and subject to increasing customer complaints; at the same time, the global recession has negatively affected the high-end market. In his first year, the new president has made significant progress in restructuring the organization and shifting its culture to a more entrepreneurial one. He is ready to begin the development of an entirely new product but has to decide on strategy, in particular deciding on the best market on which to focus the new software product and then mapping out a plan to execute its development and launch. How can he elicit a radical innovation from a team of management and employees so culturally rooted in their past accomplishments and legacy products? Should he look for a technology partner and develop the new product in a different location? Can the legacy products be kept up and running long enough for the new product to generate sufficient sales that they can be retired? These are the issues that must be addressed or the company may well face a dire future. See A Case 9B14C022. Author Susan Fleming is affiliated with Cornell University. Author Alyssa W. Goldman is affiliated with Concept Systems, Inc.

Case Authors : Susan Fleming, Alyssa W. Goldman

Topic : Technology & Operations

Related Areas : Innovation, Organizational culture, Technology

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Calculating Net Present Value (NPV) at 6% for Driving Innovation at PAR Springer-Miller (B) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019881)	-10019881	-	-
Year 1	3458023	-6561858	3458023	0.9434	3262286
Year 2	3978940	-2582918	7436963	0.89	3541242
Year 3	3943868	1360950	11380831	0.8396	3311348
Year 4	3248388	4609338	14629219	0.7921	2573028
TOTAL			14629219		12687903

The Net Present Value at 6% discount rate is 2668022

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. Payback Period
2. Profitability Index
3. Internal Rate of Return
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 Legacy Springer 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. Legacy Springer 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 Driving Innovation at PAR Springer-Miller (B)

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 Legacy Springer 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 Legacy Springer 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	(10019881)	-10019881	-	-
Year 1	3458023	-6561858	3458023	0.8696	3006977
Year 2	3978940	-2582918	7436963	0.7561	3008650
Year 3	3943868	1360950	11380831	0.6575	2593157
Year 4	3248388	4609338	14629219	0.5718	1857276
TOTAL					10466060

The Net NPV after 4 years is 446179

(10466060 - 10019881 )

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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	(10019881)	-10019881	-	-
Year 1	3458023	-6561858	3458023	0.8333	2881686
Year 2	3978940	-2582918	7436963	0.6944	2763153
Year 3	3943868	1360950	11380831	0.5787	2282331
Year 4	3248388	4609338	14629219	0.4823	1566545
TOTAL					9493715

The Net NPV after 4 years is -526166

At 20% discount rate the NPV is negative (9493715 - 10019881 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Legacy Springer 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 Legacy Springer has a NPV value higher than Zero then finance managers at Legacy Springer 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 Legacy Springer, then the stock price of the Legacy Springer 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 Legacy Springer 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 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.

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.

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 Driving Innovation at PAR Springer-Miller (B)

References & Further Readings

Susan Fleming, Alyssa W. Goldman (2018), "Driving Innovation at PAR Springer-Miller (B) Harvard Business Review Case Study. Published by HBR Publications.