Applied Mobile Labs: Valuation of a Start-Up 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 Applied Mobile Labs: Valuation of a Start-Up case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Applied Mobile Labs: Valuation of a Start-Up case study is a Harvard Business School (HBR) case study written by Jaslene Kaur Bawa, Vinay Goyal, S.K. Mitra. The Applied Mobile Labs: Valuation of a Start-Up (referred as “Raipur Start” 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, International business.

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 Applied Mobile Labs: Valuation of a Start-Up Case Study

An angel investor had invested seed capital in a start-up company that aggregated and sold value-added services for mobile telecommunications in India. The company had done well since its inception in 2009, but the revenue growth figures reported for 2014 were concerning. According to the performance report, the start-up had grown 12 per cent in 2014-less than half of the estimated industry revenue growth figure for mobile value-added services. The investor wondered if his investment was profitable despite the negative cash flows and significant lifetime company losses incurred during the first three years of operation. Should the investor stay invested with, or divest from, the start-up? What would the company's exit value be? Jaslene Kaur Bawa is affiliated with Indian Institute of Management Raipur. Vinay Goyal is affiliated with Indian Institute of Management Raipur. S. K. Mitra is affiliated with Indian Institute of Management Raipur.

Case Authors : Jaslene Kaur Bawa, Vinay Goyal, S.K. Mitra

Topic : Finance & Accounting

Related Areas : Financial management, International business

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Calculating Net Present Value (NPV) at 6% for Applied Mobile Labs: Valuation of a Start-Up Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10002020)	-10002020	-	-
Year 1	3443487	-6558533	3443487	0.9434	3248573
Year 2	3955883	-2602650	7399370	0.89	3520722
Year 3	3943146	1340496	11342516	0.8396	3310741
Year 4	3243615	4584111	14586131	0.7921	2569247
TOTAL			14586131		12649283

The Net Present Value at 6% discount rate is 2647263

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. Payback Period
3. Internal Rate of Return
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. Raipur Start 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 Raipur Start 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 Applied Mobile Labs: Valuation of a Start-Up

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 Raipur Start 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 Raipur Start 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	(10002020)	-10002020	-	-
Year 1	3443487	-6558533	3443487	0.8696	2994337
Year 2	3955883	-2602650	7399370	0.7561	2991216
Year 3	3943146	1340496	11342516	0.6575	2592683
Year 4	3243615	4584111	14586131	0.5718	1854547
TOTAL					10432782

The Net NPV after 4 years is 430762

(10432782 - 10002020 )

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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	(10002020)	-10002020	-	-
Year 1	3443487	-6558533	3443487	0.8333	2869573
Year 2	3955883	-2602650	7399370	0.6944	2747141
Year 3	3943146	1340496	11342516	0.5787	2281913
Year 4	3243615	4584111	14586131	0.4823	1564243
TOTAL					9462870

The Net NPV after 4 years is -539150

At 20% discount rate the NPV is negative (9462870 - 10002020 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Raipur Start 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 Raipur Start has a NPV value higher than Zero then finance managers at Raipur Start 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 Raipur Start, then the stock price of the Raipur Start 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 Raipur Start 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 –

Understanding of risks involved in the project.

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.

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 can impact the cash flow of 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 Applied Mobile Labs: Valuation of a Start-Up

References & Further Readings

Jaslene Kaur Bawa, Vinay Goyal, S.K. Mitra (2018), "Applied Mobile Labs: Valuation of a Start-Up Harvard Business Review Case Study. Published by HBR Publications.