Bucking the Trend: A Look at Zyme Solutions' Non-linear Business Model for IT Services from India 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 Bucking the Trend: A Look at Zyme Solutions' Non-linear Business Model for IT Services from India case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Bucking the Trend: A Look at Zyme Solutions' Non-linear Business Model for IT Services from India case study is a Harvard Business School (HBR) case study written by D.V.R. Seshadri. The Bucking the Trend: A Look at Zyme Solutions' Non-linear Business Model for IT Services from India (referred as “Linear Xgen” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, IT, Supply chain.

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 Bucking the Trend: A Look at Zyme Solutions' Non-linear Business Model for IT Services from India Case Study

The case opens with XGen Technologies, a software-led IT solutions provider, being placed in a situation of having to grapple with the issues of linear growth, similar to most of the contemporary ITES companies. XGen's traditional ''linear'' business model now had Partha Sen, the CEO, seeking out new profit opportunities. The company's headcount had touched a whopping 40,000 and managing such a large setup was becoming a severe challenge. Besides, in the emerging war for talent, sourcing and retaining quality talent was another problem. An export-driven software services company, XGen earned substantial revenues in dollars, and the appreciation of the rupee by close to 15% coupled with rising salaries had impacted its profit margins in the current fiscal. All these factors, and the fact that XGen was a listed company, put immense pressure on Partha to adopt an innovative business model to ward off pressure on bottom lines, ensure sustainability of the business in the long run. Most Indian ITES companies had been clocking impressive growth, yet there were concerns about the future, particularly with regard to the burden and difficulties that were expected in manpower intensive business models that inextricably had to struggle with ever-escalating costs as well as increasing complexity in managing its humongous operations. The focus of the case then shifts to the various strategies that software companies have been adopting in order to achieve greater non-linearity in their business. In particular, the case concentrates on Zyme Solutions, Inc., a fully outsourced hosted data service provider to the high-tech vertical market, which has built a non-linear business from the ground up, without the legacy of the linear business models to contend with. The second half of the case describes in detail how Zyme Solutions has gone about constructing an innovative non-linear business model for its business.

Case Authors : D.V.R. Seshadri

Topic : Technology & Operations

Related Areas : IT, Supply chain

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Calculating Net Present Value (NPV) at 6% for Bucking the Trend: A Look at Zyme Solutions' Non-linear Business Model for IT Services from India Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10001682)	-10001682	-	-
Year 1	3452246	-6549436	3452246	0.9434	3256836
Year 2	3953072	-2596364	7405318	0.89	3518220
Year 3	3951656	1355292	11356974	0.8396	3317887
Year 4	3225343	4580635	14582317	0.7921	2554774
TOTAL			14582317		12647716

The Net Present Value at 6% discount rate is 2646034

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. Net Present Value
2. Payback Period
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Linear Xgen shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Linear Xgen have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Bucking the Trend: A Look at Zyme Solutions' Non-linear Business Model for IT Services from India

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 Linear Xgen 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 Linear Xgen 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	(10001682)	-10001682	-	-
Year 1	3452246	-6549436	3452246	0.8696	3001953
Year 2	3953072	-2596364	7405318	0.7561	2989090
Year 3	3951656	1355292	11356974	0.6575	2598278
Year 4	3225343	4580635	14582317	0.5718	1844100
TOTAL					10433422

The Net NPV after 4 years is 431740

(10433422 - 10001682 )

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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	(10001682)	-10001682	-	-
Year 1	3452246	-6549436	3452246	0.8333	2876872
Year 2	3953072	-2596364	7405318	0.6944	2745189
Year 3	3951656	1355292	11356974	0.5787	2286838
Year 4	3225343	4580635	14582317	0.4823	1555432
TOTAL					9464330

The Net NPV after 4 years is -537352

At 20% discount rate the NPV is negative (9464330 - 10001682 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Linear Xgen 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 Linear Xgen has a NPV value higher than Zero then finance managers at Linear Xgen 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 Linear Xgen, then the stock price of the Linear Xgen 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 Linear Xgen 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 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.

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 Bucking the Trend: A Look at Zyme Solutions' Non-linear Business Model for IT Services from India

References & Further Readings

D.V.R. Seshadri (2018), "Bucking the Trend: A Look at Zyme Solutions' Non-linear Business Model for IT Services from India Harvard Business Review Case Study. Published by HBR Publications.