Haier: Incubating Entrepreneurs in a Chinese Giant 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 Haier: Incubating Entrepreneurs in a Chinese Giant case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Haier: Incubating Entrepreneurs in a Chinese Giant case study is a Harvard Business School (HBR) case study written by Rosabeth Moss Kanter, Nancy Hua Dai. The Haier: Incubating Entrepreneurs in a Chinese Giant (referred as “Haier Micro” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Entrepreneurship, Innovation, IT, Leadership.

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 Haier: Incubating Entrepreneurs in a Chinese Giant Case Study

CEO Zhang Ruimin must plan how to accelerate the growth of self-managed micro-enterprises. Platforms were Haier's business platforms operating in five major sectors: white goods transformation, investment and incubation, financial holdings, real estate, and cultural industry. Platform owners incubated micro-enterprises on their platforms with the resources Haier had, but they were not the supervisors of micro-enterprises. His goal was to tear down the walls between the organization, shortening the time the company took to respond to users' needs, with the ultimate goal of "zero distance" between employees and users. Haier had engaged in a series of organizational changes since 2005, the most recent of which started in 2012. His latest experimentation was turning Haier into a platform for entrepreneurship. Employees and those outside Haier could set up micro-enterprises on Haier's platforms. Zhang thought Haier was on the right track, but the model had to prove itself in practice. He set a timetable: the micro-enterprises must reach the tipping point by September 20, 2018, which meant the micro-enterprise would have become a platform to which all resource providers would flock and stay loyal. There was no precedent of transformation like this anywhere. Would Haier succeed? What could Haier do to push the micro-enterprises to get to the tipping point?

Case Authors : Rosabeth Moss Kanter, Nancy Hua Dai

Topic : Leadership & Managing People

Related Areas : Entrepreneurship, Innovation, IT, Leadership

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Calculating Net Present Value (NPV) at 6% for Haier: Incubating Entrepreneurs in a Chinese Giant Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018641)	-10018641	-	-
Year 1	3465591	-6553050	3465591	0.9434	3269425
Year 2	3954672	-2598378	7420263	0.89	3519644
Year 3	3974630	1376252	11394893	0.8396	3337176
Year 4	3225982	4602234	14620875	0.7921	2555280
TOTAL			14620875		12681525

The Net Present Value at 6% discount rate is 2662884

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. Profitability Index
4. Payback Period

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 Haier Micro 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. Haier Micro 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 Haier: Incubating Entrepreneurs in a Chinese Giant

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 Leadership & Managing People 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 Haier Micro 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 Haier Micro 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	(10018641)	-10018641	-	-
Year 1	3465591	-6553050	3465591	0.8696	3013557
Year 2	3954672	-2598378	7420263	0.7561	2990300
Year 3	3974630	1376252	11394893	0.6575	2613384
Year 4	3225982	4602234	14620875	0.5718	1844466
TOTAL					10461707

The Net NPV after 4 years is 443066

(10461707 - 10018641 )

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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	(10018641)	-10018641	-	-
Year 1	3465591	-6553050	3465591	0.8333	2887993
Year 2	3954672	-2598378	7420263	0.6944	2746300
Year 3	3974630	1376252	11394893	0.5787	2300133
Year 4	3225982	4602234	14620875	0.4823	1555740
TOTAL					9490165

The Net NPV after 4 years is -528476

At 20% discount rate the NPV is negative (9490165 - 10018641 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Haier Micro 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 Haier Micro has a NPV value higher than Zero then finance managers at Haier Micro 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 Haier Micro, then the stock price of the Haier Micro 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 Haier Micro 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.

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.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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 Haier: Incubating Entrepreneurs in a Chinese Giant

References & Further Readings

Rosabeth Moss Kanter, Nancy Hua Dai (2018), "Haier: Incubating Entrepreneurs in a Chinese Giant Harvard Business Review Case Study. Published by HBR Publications.