The Whistleblower at International Game Technology 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 The Whistleblower at International Game Technology case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Whistleblower at International Game Technology case study is a Harvard Business School (HBR) case study written by Aiyesha Dey, Jonas Heese, James Weber. The The Whistleblower at International Game Technology (referred as “Whistleblower Mayhem” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Ethics, Government.

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 The Whistleblower at International Game Technology Case Study

Robert Mayhem, a senior manager at International Game Technology, had filed a whistleblower report with the U.S. Securities and Exchange Commission alleging that the company has misstatements in its financial reports. Mayhem's report involved IGT's practice of refurbishing used parts in one of its reporting segments and then transferring those parts to another reporting segment. Mayhem indicated that IGT's method of determining the costs of the refurbished parts was inaccurate and resulted in profits being shifted from one segment to another. Prior to his report to the SEC, Mayhem had reported his concerns to his managers and to the company's internal compliance hotline. At about the same time, IGT announced that it had accepted an offer to be acquired by another large player in the industry which would soon move its incorporation out of the U.S. and into the U.K. What should IGT do regarding the whistleblower and his report?

Case Authors : Aiyesha Dey, Jonas Heese, James Weber

Topic : Finance & Accounting

Related Areas : Ethics, Government

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Calculating Net Present Value (NPV) at 6% for The Whistleblower at International Game Technology Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10010828)	-10010828	-	-
Year 1	3462974	-6547854	3462974	0.9434	3266957
Year 2	3958694	-2589160	7421668	0.89	3523224
Year 3	3939636	1350476	11361304	0.8396	3307794
Year 4	3225810	4576286	14587114	0.7921	2555144
TOTAL			14587114		12653118

The Net Present Value at 6% discount rate is 2642290

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

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. Whistleblower Mayhem 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 Whistleblower Mayhem 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 The Whistleblower at International Game Technology

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 Whistleblower Mayhem 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 Whistleblower Mayhem 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	(10010828)	-10010828	-	-
Year 1	3462974	-6547854	3462974	0.8696	3011282
Year 2	3958694	-2589160	7421668	0.7561	2993341
Year 3	3939636	1350476	11361304	0.6575	2590375
Year 4	3225810	4576286	14587114	0.5718	1844367
TOTAL					10439365

The Net NPV after 4 years is 428537

(10439365 - 10010828 )

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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	(10010828)	-10010828	-	-
Year 1	3462974	-6547854	3462974	0.8333	2885812
Year 2	3958694	-2589160	7421668	0.6944	2749093
Year 3	3939636	1350476	11361304	0.5787	2279882
Year 4	3225810	4576286	14587114	0.4823	1555657
TOTAL					9470443

The Net NPV after 4 years is -540385

At 20% discount rate the NPV is negative (9470443 - 10010828 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Whistleblower Mayhem 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 Whistleblower Mayhem has a NPV value higher than Zero then finance managers at Whistleblower Mayhem 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 Whistleblower Mayhem, then the stock price of the Whistleblower Mayhem 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 Whistleblower Mayhem 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.

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.

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.

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 The Whistleblower at International Game Technology

References & Further Readings

Aiyesha Dey, Jonas Heese, James Weber (2018), "The Whistleblower at International Game Technology Harvard Business Review Case Study. Published by HBR Publications.