NetGuardians: Beating Fraud From the Inside 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 NetGuardians: Beating Fraud From the Inside case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. NetGuardians: Beating Fraud From the Inside case study is a Harvard Business School (HBR) case study written by Carlos Cordon, Teresa Ferreiro. The NetGuardians: Beating Fraud From the Inside (referred as “Netguardians Raffael” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Data, Entrepreneurship, Ethics, Financial management, 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 NetGuardians: Beating Fraud From the Inside Case Study

After developing powerful software, young entrepreneurs Raffael Maio and JoA?l Winteregg, founded NetGuardians in 2007. Their initial idea was to help companies improve security. (i) Over time, the two entrepreneurs improved their technology and decided to focus on defeating and preventing fraud in banking, where there was a gap in the market. In 2014 around $67 billion was lost due to banking fraud, 70% of it committed by employees inside the company. In 2015 the company was named a Gartner Cool Vendor, a worldwide industry recognition for companies that offer technologies or solutions that are innovative, impactful and intriguing. (ii) In the nine years since they had founded their company, JoA?l and Raffael had raised $6 billion in two rounds of funding. The company employed around 30 people in R&D offices in Kenya, Singapore and Poland. It had customers in Africa, the Middle East and Europe, and was breaking ground in Asia. (iii) Now it was time for NetGuardians to tackle some important strategic decisions: Should the company expand to other markets? Should it expand its product offering? Or should it focus on growing its customer base? (iv) Whatever the decision, it would lead to a change in business model that would have a significant impact on the company.

Case Authors : Carlos Cordon, Teresa Ferreiro

Topic : Technology & Operations

Related Areas : Data, Entrepreneurship, Ethics, Financial management, Technology

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Calculating Net Present Value (NPV) at 6% for NetGuardians: Beating Fraud From the Inside Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10004549)	-10004549	-	-
Year 1	3465232	-6539317	3465232	0.9434	3269087
Year 2	3970472	-2568845	7435704	0.89	3533706
Year 3	3958857	1390012	11394561	0.8396	3323933
Year 4	3224517	4614529	14619078	0.7921	2554119
TOTAL			14619078		12680845

The Net Present Value at 6% discount rate is 2676296

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 Netguardians Raffael 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. Netguardians Raffael 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 NetGuardians: Beating Fraud From the Inside

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 Netguardians Raffael 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 Netguardians Raffael 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	(10004549)	-10004549	-	-
Year 1	3465232	-6539317	3465232	0.8696	3013245
Year 2	3970472	-2568845	7435704	0.7561	3002247
Year 3	3958857	1390012	11394561	0.6575	2603013
Year 4	3224517	4614529	14619078	0.5718	1843628
TOTAL					10462133

The Net NPV after 4 years is 457584

(10462133 - 10004549 )

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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	(10004549)	-10004549	-	-
Year 1	3465232	-6539317	3465232	0.8333	2887693
Year 2	3970472	-2568845	7435704	0.6944	2757272
Year 3	3958857	1390012	11394561	0.5787	2291005
Year 4	3224517	4614529	14619078	0.4823	1555033
TOTAL					9491004

The Net NPV after 4 years is -513545

At 20% discount rate the NPV is negative (9491004 - 10004549 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Netguardians Raffael 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 Netguardians Raffael has a NPV value higher than Zero then finance managers at Netguardians Raffael 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 Netguardians Raffael, then the stock price of the Netguardians Raffael 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 Netguardians Raffael 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.

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

Understanding of risks involved in the project.

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.

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Negotiation Strategy of NetGuardians: Beating Fraud From the Inside

References & Further Readings

Carlos Cordon, Teresa Ferreiro (2018), "NetGuardians: Beating Fraud From the Inside Harvard Business Review Case Study. Published by HBR Publications.