×




Strategic Management of Product Recovery 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 Strategic Management of Product Recovery case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Strategic Management of Product Recovery case study is a Harvard Business School (HBR) case study written by Michael W. Toffel. The Strategic Management of Product Recovery (referred as “Recovery Eol” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Supply chain, Sustainability.

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 Strategic Management of Product Recovery Case Study


A growing concern for durable product manufacturers is how to manage the products they manufacture when they reach their end of life (EOL). In part, this attention is motivated by a growing number of countries across Europe and East Asia that are enacting legislation that imposes greater responsibilities on manufacturers for managing their EOL products. Even in nonregulated markets, however, some manufacturers are engaging in product recovery to reduce production costs, enhance brand image, meet changing customer expectations, protect aftermarkets, and preempt pending legislation or regulations. Explains when manufacturers should engage in product recovery efforts through partnerships, alliances, or vertical integration and when they should leave this task to independent firms. Technologies that enhance the productivity of product recovery, the level of uncertainty associated with reverse logistics, diverse manufacturing-related capabilities, the uniqueness of recovered assets, and the desire to avoid dependence on other organizations are key determinants that shape the industrial organization of EOL product recovery.


Case Authors : Michael W. Toffel

Topic : Technology & Operations

Related Areas : Supply chain, Sustainability




Calculating Net Present Value (NPV) at 6% for Strategic Management of Product Recovery Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10000663) -10000663 - -
Year 1 3447212 -6553451 3447212 0.9434 3252087
Year 2 3954990 -2598461 7402202 0.89 3519927
Year 3 3964998 1366537 11367200 0.8396 3329089
Year 4 3251103 4617640 14618303 0.7921 2575178
TOTAL 14618303 12676281




The Net Present Value at 6% discount rate is 2675618

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. Profitability Index
2. Payback Period
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 Recovery Eol 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. Recovery Eol 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 Strategic Management of Product Recovery

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 Recovery Eol 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 Recovery Eol 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 (10000663) -10000663 - -
Year 1 3447212 -6553451 3447212 0.8696 2997576
Year 2 3954990 -2598461 7402202 0.7561 2990541
Year 3 3964998 1366537 11367200 0.6575 2607051
Year 4 3251103 4617640 14618303 0.5718 1858829
TOTAL 10453996


The Net NPV after 4 years is 453333

(10453996 - 10000663 )








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 (10000663) -10000663 - -
Year 1 3447212 -6553451 3447212 0.8333 2872677
Year 2 3954990 -2598461 7402202 0.6944 2746521
Year 3 3964998 1366537 11367200 0.5787 2294559
Year 4 3251103 4617640 14618303 0.4823 1567854
TOTAL 9481611


The Net NPV after 4 years is -519052

At 20% discount rate the NPV is negative (9481611 - 10000663 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Recovery Eol 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 Recovery Eol has a NPV value higher than Zero then finance managers at Recovery Eol 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 Recovery Eol, then the stock price of the Recovery Eol 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 Recovery Eol 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 will be a multi year spillover effect of various taxation regulations.

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.

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.






Negotiation Strategy of Strategic Management of Product Recovery

References & Further Readings

Michael W. Toffel (2018), "Strategic Management of Product Recovery Harvard Business Review Case Study. Published by HBR Publications.


SK Telecom SWOT Analysis / TOWS Matrix

Services , Communications Services


Welcron SWOT Analysis / TOWS Matrix

Consumer Cyclical , Textiles - Non Apparel


Ningbo Fubang SWOT Analysis / TOWS Matrix

Basic Materials , Metal Mining


Tokai Corp SWOT Analysis / TOWS Matrix

Healthcare , Medical Equipment & Supplies


Henan Yicheng SWOT Analysis / TOWS Matrix

Capital Goods , Constr. - Supplies & Fixtures


Kabe Exploration SWOT Analysis / TOWS Matrix

Financial , Misc. Financial Services


Hikma Pharma SWOT Analysis / TOWS Matrix

Healthcare , Biotechnology & Drugs


Qudian Inc SWOT Analysis / TOWS Matrix

Technology , Software & Programming


Iofina SWOT Analysis / TOWS Matrix

Basic Materials , Chemical Manufacturing