MGM Resorts International: Accounts Receivable 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 MGM Resorts International: Accounts Receivable case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. MGM Resorts International: Accounts Receivable case study is a Harvard Business School (HBR) case study written by Luann J. Lynch. The MGM Resorts International: Accounts Receivable (referred as “Receivable Mgm” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Financial 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

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Case Description of MGM Resorts International: Accounts Receivable Case Study

An analyst's The manager at a local investment firm had been reading through a recent report regarding MGM Resorts International when he noticed a drop in the company's bad debt expense estimate for 2016. He had asked an analyst at the firm to investigate. The manager knew a decrease like this could indicate an improvement in collectability from customers, but he also knew the expense was subject to estimates from management. He needed to know whether to interpret the decline as a good sign or not. This case is intended for use in an introductory financial accounting course to demonstrate the impact of accounts receivable on financial statements.

Case Authors : Luann J. Lynch

Topic : Finance & Accounting

Related Areas : Financial management

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Calculating Net Present Value (NPV) at 6% for MGM Resorts International: Accounts Receivable Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016185)	-10016185	-	-
Year 1	3448930	-6567255	3448930	0.9434	3253708
Year 2	3982877	-2584378	7431807	0.89	3544746
Year 3	3950376	1365998	11382183	0.8396	3316812
Year 4	3233218	4599216	14615401	0.7921	2561011
TOTAL			14615401		12676277

The Net Present Value at 6% discount rate is 2660092

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. Profitability Index
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. Receivable Mgm 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 Receivable Mgm 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 MGM Resorts International: Accounts Receivable

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 Finance & Accounting 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 Receivable Mgm 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 Receivable Mgm 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	(10016185)	-10016185	-	-
Year 1	3448930	-6567255	3448930	0.8696	2999070
Year 2	3982877	-2584378	7431807	0.7561	3011627
Year 3	3950376	1365998	11382183	0.6575	2597436
Year 4	3233218	4599216	14615401	0.5718	1848603
TOTAL					10456736

The Net NPV after 4 years is 440551

(10456736 - 10016185 )

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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	(10016185)	-10016185	-	-
Year 1	3448930	-6567255	3448930	0.8333	2874108
Year 2	3982877	-2584378	7431807	0.6944	2765887
Year 3	3950376	1365998	11382183	0.5787	2286097
Year 4	3233218	4599216	14615401	0.4823	1559229
TOTAL					9485322

The Net NPV after 4 years is -530863

At 20% discount rate the NPV is negative (9485322 - 10016185 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Receivable Mgm 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 Receivable Mgm has a NPV value higher than Zero then finance managers at Receivable Mgm 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 Receivable Mgm, then the stock price of the Receivable Mgm 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 Receivable Mgm 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 key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

What can impact the cash flow of the project.

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.

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 MGM Resorts International: Accounts Receivable

References & Further Readings

Luann J. Lynch (2018), "MGM Resorts International: Accounts Receivable Harvard Business Review Case Study. Published by HBR Publications.