UCB: Data is the New Drug 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 UCB: Data is the New Drug case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. UCB: Data is the New Drug case study is a Harvard Business School (HBR) case study written by Stijn Viaene. The UCB: Data is the New Drug (referred as “Ucb Analytics” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Data.

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 UCB: Data is the New Drug Case Study

At the end of 2012, the chief information officer (CIO) at UCB, a global pharmaceutical company based in Brussels, started to implement analytics as a service. Between 2012 and 2016, he put this vision into practice, introducing agile sprints and proving the competence of analytics within the organization, and at the beginning of 2016, he felt the company was ready to upgrade its analytics capability. As he prepared to meet with UCB's chief executive officer in March 2016, the CIO considered how to advise the board as the organization worked to make an impact with analytics and big data against the backdrop of digital turbulence in its strategic environment. How could UCB balance empowerment and bottom-up experimentation with enterprise focus and control? What was the best location for analytics roles and responsibilities within the organization? Stijn Viaene is affiliated with Vlerick Business School.

Case Authors : Stijn Viaene

Topic : Technology & Operations

Related Areas : Data

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Calculating Net Present Value (NPV) at 6% for UCB: Data is the New Drug Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018698)	-10018698	-	-
Year 1	3469689	-6549009	3469689	0.9434	3273292
Year 2	3979163	-2569846	7448852	0.89	3541441
Year 3	3955945	1386099	11404797	0.8396	3321488
Year 4	3230447	4616546	14635244	0.7921	2558817
TOTAL			14635244		12695037

The Net Present Value at 6% discount rate is 2676339

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. Internal Rate of Return
3. Payback Period
4. Profitability Index

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 Ucb Analytics 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. Ucb Analytics shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of UCB: Data is the New Drug

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 Ucb Analytics 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 Ucb Analytics 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	(10018698)	-10018698	-	-
Year 1	3469689	-6549009	3469689	0.8696	3017121
Year 2	3979163	-2569846	7448852	0.7561	3008819
Year 3	3955945	1386099	11404797	0.6575	2601098
Year 4	3230447	4616546	14635244	0.5718	1847019
TOTAL					10474056

The Net NPV after 4 years is 455358

(10474056 - 10018698 )

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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	(10018698)	-10018698	-	-
Year 1	3469689	-6549009	3469689	0.8333	2891408
Year 2	3979163	-2569846	7448852	0.6944	2763308
Year 3	3955945	1386099	11404797	0.5787	2289320
Year 4	3230447	4616546	14635244	0.4823	1557893
TOTAL					9501928

The Net NPV after 4 years is -516770

At 20% discount rate the NPV is negative (9501928 - 10018698 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ucb Analytics 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 Ucb Analytics has a NPV value higher than Zero then finance managers at Ucb Analytics 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 Ucb Analytics, then the stock price of the Ucb Analytics 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 Ucb Analytics 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.

What can impact the cash flow of the project.

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.

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Negotiation Strategy of UCB: Data is the New Drug

References & Further Readings

Stijn Viaene (2018), "UCB: Data is the New Drug Harvard Business Review Case Study. Published by HBR Publications.