San Francisco International Airport and Quantum Secure's SAFE for Aviation System 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 San Francisco International Airport and Quantum Secure's SAFE for Aviation System case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. San Francisco International Airport and Quantum Secure's SAFE for Aviation System case study is a Harvard Business School (HBR) case study written by Daniel Diermeier, Evan Meagher. The San Francisco International Airport and Quantum Secure's SAFE for Aviation System (referred as “Secure's Airport” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Financial management, IT, Operations management, Public relations, Regulation.

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 San Francisco International Airport and Quantum Secure's SAFE for Aviation System Case Study

In 2008 San Francisco International Airport (known by its three-letter airport code, SFO) had announced a $383 million plan to renovate and reopen Terminal 2. Assistant deputy director of aviation security Kim Dickie and her team had selected Quantum Secure's SAFE software suite as the new Terminal 2 credentialing system, but she needed to develop a business case quickly that would convince senior management to give the green light to fund the purchase. The case describes a scenario that occurs frequently in the real world, in which a decision offers some real but qualitative value in ways that are difficult or impossible to quantify. The discussion and analysis gives students the opportunity to consider the factors that will drive the internal rate of return (IRR), net present value (NPV), and discounted payback period calculations without constructing comprehensive spreadsheet models. Analyzing the case suggests the limits of such approaches in cases where perceived value is difficult to quantify. The case prepares students to evaluate and justify purchasing requests when interacting with financial gatekeepers such as CFOs and CEOs by introducing a framework to analyze the quantifiable benefits of a capital expenditure while keeping in mind important intangible benefits.

Case Authors : Daniel Diermeier, Evan Meagher

Topic : Technology & Operations

Related Areas : Financial management, IT, Operations management, Public relations, Regulation

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Calculating Net Present Value (NPV) at 6% for San Francisco International Airport and Quantum Secure's SAFE for Aviation System Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10007487)	-10007487	-	-
Year 1	3457403	-6550084	3457403	0.9434	3261701
Year 2	3965578	-2584506	7422981	0.89	3529350
Year 3	3960943	1376437	11383924	0.8396	3325684
Year 4	3227863	4604300	14611787	0.7921	2556770
TOTAL			14611787		12673505

The Net Present Value at 6% discount rate is 2666018

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

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. Secure's Airport 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 Secure's Airport 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 San Francisco International Airport and Quantum Secure's SAFE for Aviation System

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 Secure's Airport 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 Secure's Airport 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	(10007487)	-10007487	-	-
Year 1	3457403	-6550084	3457403	0.8696	3006437
Year 2	3965578	-2584506	7422981	0.7561	2998547
Year 3	3960943	1376437	11383924	0.6575	2604384
Year 4	3227863	4604300	14611787	0.5718	1845541
TOTAL					10454910

The Net NPV after 4 years is 447423

(10454910 - 10007487 )

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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	(10007487)	-10007487	-	-
Year 1	3457403	-6550084	3457403	0.8333	2881169
Year 2	3965578	-2584506	7422981	0.6944	2753874
Year 3	3960943	1376437	11383924	0.5787	2292212
Year 4	3227863	4604300	14611787	0.4823	1556647
TOTAL					9483902

The Net NPV after 4 years is -523585

At 20% discount rate the NPV is negative (9483902 - 10007487 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Secure's Airport 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 Secure's Airport has a NPV value higher than Zero then finance managers at Secure's Airport 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 Secure's Airport, then the stock price of the Secure's Airport 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 Secure's Airport 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 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.

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.

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 San Francisco International Airport and Quantum Secure's SAFE for Aviation System

References & Further Readings

Daniel Diermeier, Evan Meagher (2018), "San Francisco International Airport and Quantum Secure's SAFE for Aviation System Harvard Business Review Case Study. Published by HBR Publications.