Kulicke and Soffa Industries Inc. in China: Transferring Knowledge (A) 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 Kulicke and Soffa Industries Inc. in China: Transferring Knowledge (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Kulicke and Soffa Industries Inc. in China: Transferring Knowledge (A) case study is a Harvard Business School (HBR) case study written by Gerry Yemen, Gal Raz, Martin N. Davidson. The Kulicke and Soffa Industries Inc. in China: Transferring Knowledge (A) (referred as “Capillaries Dicing” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Knowledge management.

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 Kulicke and Soffa Industries Inc. in China: Transferring Knowledge (A) Case Study

While much of the work on outsourcing to China focuses on the low cost and its tradeoffs, this case examines in depth the interaction between human capital and a firm's cost and capabilities. Suitable for the MBA, EMBA, GEMBA, and executive education programs, the case presents a manufacturer of semiconductor assembly equipment looking to achieve growth in its wire bonding tools segment-in particular, capillaries and dicing saw blades-through geographic expansion. At the time, it manufactured capillaries in Yokneam, Israel, and blades in Santa Clara, California. In the A case the team is charged with designing and opening a new facility in Suzhou, China. Expanding operations to China meant cost savings, and it was where K&S's market had expanded. But it wasn't clear whether it made sense to move the capillary process, the dicing blade manufacturing, or both. And if K&S did move to China, should it keep the Israeli- and American-based factories open as well? And once those decisions were made, what exactly would the knowledge transfer look like?

Case Authors : Gerry Yemen, Gal Raz, Martin N. Davidson

Topic : Technology & Operations

Related Areas : Knowledge management

Calculating Net Present Value (NPV) at 6% for Kulicke and Soffa Industries Inc. in China: Transferring Knowledge (A) Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10025514) -10025514 - -
Year 1 3464654 -6560860 3464654 0.9434 3268542
Year 2 3956620 -2604240 7421274 0.89 3521378
Year 3 3964493 1360253 11385767 0.8396 3328665
Year 4 3244839 4605092 14630606 0.7921 2570216
TOTAL 14630606 12688800

The Net Present Value at 6% discount rate is 2663286

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. Internal Rate of Return
2. Net Present Value
3. Profitability Index
4. Payback Period

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 Capillaries Dicing 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. Capillaries Dicing 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 Kulicke and Soffa Industries Inc. in China: Transferring Knowledge (A)

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 Capillaries Dicing 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 Capillaries Dicing 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 %
Cash Flows
Year 0 (10025514) -10025514 - -
Year 1 3464654 -6560860 3464654 0.8696 3012743
Year 2 3956620 -2604240 7421274 0.7561 2991773
Year 3 3964493 1360253 11385767 0.6575 2606719
Year 4 3244839 4605092 14630606 0.5718 1855247
TOTAL 10466481

The Net NPV after 4 years is 440967

(10466481 - 10025514 )

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 %
Cash Flows
Year 0 (10025514) -10025514 - -
Year 1 3464654 -6560860 3464654 0.8333 2887212
Year 2 3956620 -2604240 7421274 0.6944 2747653
Year 3 3964493 1360253 11385767 0.5787 2294267
Year 4 3244839 4605092 14630606 0.4823 1564834
TOTAL 9493965

The Net NPV after 4 years is -531549

At 20% discount rate the NPV is negative (9493965 - 10025514 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Capillaries Dicing 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 Capillaries Dicing has a NPV value higher than Zero then finance managers at Capillaries Dicing 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 Capillaries Dicing, then the stock price of the Capillaries Dicing 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 Capillaries Dicing 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 –

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.

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.

References & Further Readings

Gerry Yemen, Gal Raz, Martin N. Davidson (2018), "Kulicke and Soffa Industries Inc. in China: Transferring Knowledge (A) Harvard Business Review Case Study. Published by HBR Publications.