Fast-Tracking Friction Plate Validation Testing: BorgWarner Improves Efficiency with Machine Learning Methodology 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 Fast-Tracking Friction Plate Validation Testing: BorgWarner Improves Efficiency with Machine Learning Methodology case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Fast-Tracking Friction Plate Validation Testing: BorgWarner Improves Efficiency with Machine Learning Methodology case study is a Harvard Business School (HBR) case study written by Prakash Sathe. The Fast-Tracking Friction Plate Validation Testing: BorgWarner Improves Efficiency with Machine Learning Methodology (referred as “Borgwarner Friction” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, .

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 Fast-Tracking Friction Plate Validation Testing: BorgWarner Improves Efficiency with Machine Learning Methodology Case Study

This case describes the process BorgWarner Transmission Systems undertook when an increase in demand required that it create new production lines in another country. To minimize inventory costs, the company engaged with a graduate student team from the University of Michigan's Tauber Institute for Global Operations for assistance with creating optimal operating procedures. The student team was tasked with developing a prediction tool to ensure a high probability that BorgWarner friction plate samples would pass pre-production verification testing. The case provides students with an overview of the production and quality assurance processes for friction plate manufacture, as well as data classification models for machine learning. Students then develop a reliable forecasting methodology to systematically evaluate process parameters and maximize test pass rates for friction plates.

Case Authors : Prakash Sathe

Topic : Technology & Operations

Related Areas :

---

Calculating Net Present Value (NPV) at 6% for Fast-Tracking Friction Plate Validation Testing: BorgWarner Improves Efficiency with Machine Learning Methodology Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10011815)	-10011815	-	-
Year 1	3458223	-6553592	3458223	0.9434	3262475
Year 2	3980053	-2573539	7438276	0.89	3542233
Year 3	3960975	1387436	11399251	0.8396	3325711
Year 4	3233348	4620784	14632599	0.7921	2561114
TOTAL			14632599		12691533

The Net Present Value at 6% discount rate is 2679718

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. Net Present Value
3. Payback Period
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. Borgwarner Friction 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 Borgwarner Friction have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

---

Formula and Steps to Calculate Net Present Value (NPV) of Fast-Tracking Friction Plate Validation Testing: BorgWarner Improves Efficiency with Machine Learning Methodology

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 Borgwarner Friction 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 Borgwarner Friction 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	(10011815)	-10011815	-	-
Year 1	3458223	-6553592	3458223	0.8696	3007150
Year 2	3980053	-2573539	7438276	0.7561	3009492
Year 3	3960975	1387436	11399251	0.6575	2604405
Year 4	3233348	4620784	14632599	0.5718	1848677
TOTAL					10469725

The Net NPV after 4 years is 457910

(10469725 - 10011815 )

---

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	(10011815)	-10011815	-	-
Year 1	3458223	-6553592	3458223	0.8333	2881853
Year 2	3980053	-2573539	7438276	0.6944	2763926
Year 3	3960975	1387436	11399251	0.5787	2292231
Year 4	3233348	4620784	14632599	0.4823	1559292
TOTAL					9497301

The Net NPV after 4 years is -514514

At 20% discount rate the NPV is negative (9497301 - 10011815 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Borgwarner Friction 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 Borgwarner Friction has a NPV value higher than Zero then finance managers at Borgwarner Friction 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 Borgwarner Friction, then the stock price of the Borgwarner Friction 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 Borgwarner Friction 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 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.

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.

---

Negotiation Strategy of Fast-Tracking Friction Plate Validation Testing: BorgWarner Improves Efficiency with Machine Learning Methodology

References & Further Readings

Prakash Sathe (2018), "Fast-Tracking Friction Plate Validation Testing: BorgWarner Improves Efficiency with Machine Learning Methodology Harvard Business Review Case Study. Published by HBR Publications.