×




Changhong: Journey to Shared Services 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 Changhong: Journey to Shared Services case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Changhong: Journey to Shared Services case study is a Harvard Business School (HBR) case study written by F. Warren McFarlan, Haiyan Zhang, Guo Jia. The Changhong: Journey to Shared Services (referred as “Changhong Electronics” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, .

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






Case Description of Changhong: Journey to Shared Services Case Study


Founded in 1958 and headquartered in Mianyang - an emerging inland science and technology city in Sichuan Province, Changhong Electric Co., Ltd., started from the military industry. It then entered the color TV industry and subsequently expanded to a wide range of sectors including black electronics, white electronics, IT/communication, services and parts. It is now an integrated multinational corporation (combining R&D and manufacturing for the military industry, consumer electronics, electronic components, etc.) This case shows how a large TV manufacturer has transformed its internal controls to deal with both fiscal austerity and emerging global practice. It demonstrates the new financial control environment in China in 2014 for leading companies and the immense challenges involved in implementing new controls.


Case Authors : F. Warren McFarlan, Haiyan Zhang, Guo Jia

Topic : Finance & Accounting

Related Areas :




Calculating Net Present Value (NPV) at 6% for Changhong: Journey to Shared Services Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10022831) -10022831 - -
Year 1 3450607 -6572224 3450607 0.9434 3255290
Year 2 3969979 -2602245 7420586 0.89 3533267
Year 3 3967743 1365498 11388329 0.8396 3331394
Year 4 3238694 4604192 14627023 0.7921 2565349
TOTAL 14627023 12685299




The Net Present Value at 6% discount rate is 2662468

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.




Capital Budgeting Approaches

Methods of Capital Budgeting


There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Internal Rate of Return
2. Payback Period
3. Profitability Index
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. Timing of the expected cash flows – stockholders of Changhong Electronics 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. Changhong Electronics shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of Changhong: Journey to Shared Services

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 Changhong Electronics 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 Changhong Electronics 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 (10022831) -10022831 - -
Year 1 3450607 -6572224 3450607 0.8696 3000528
Year 2 3969979 -2602245 7420586 0.7561 3001874
Year 3 3967743 1365498 11388329 0.6575 2608855
Year 4 3238694 4604192 14627023 0.5718 1851734
TOTAL 10462992


The Net NPV after 4 years is 440161

(10462992 - 10022831 )








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 (10022831) -10022831 - -
Year 1 3450607 -6572224 3450607 0.8333 2875506
Year 2 3969979 -2602245 7420586 0.6944 2756930
Year 3 3967743 1365498 11388329 0.5787 2296148
Year 4 3238694 4604192 14627023 0.4823 1561870
TOTAL 9490453


The Net NPV after 4 years is -532378

At 20% discount rate the NPV is negative (9490453 - 10022831 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Changhong Electronics 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 Changhong Electronics has a NPV value higher than Zero then finance managers at Changhong Electronics 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 Changhong Electronics, then the stock price of the Changhong Electronics 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 Changhong Electronics 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 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 will be a multi year spillover effect of various taxation regulations.

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.






Negotiation Strategy of Changhong: Journey to Shared Services

References & Further Readings

F. Warren McFarlan, Haiyan Zhang, Guo Jia (2018), "Changhong: Journey to Shared Services Harvard Business Review Case Study. Published by HBR Publications.


ESI Group SWOT Analysis / TOWS Matrix

Technology , Software & Programming


Home Depot SWOT Analysis / TOWS Matrix

Services , Retail (Home Improvement)


Kodama Chemical Industry SWOT Analysis / TOWS Matrix

Consumer Cyclical , Auto & Truck Parts


Kangmei Pharm SWOT Analysis / TOWS Matrix

Healthcare , Biotechnology & Drugs


Sano SWOT Analysis / TOWS Matrix

Consumer/Non-Cyclical , Personal & Household Prods.


Nine Energy SWOT Analysis / TOWS Matrix

Energy , Oil Well Services & Equipment


AVCON Information Tech SWOT Analysis / TOWS Matrix

Technology , Communications Equipment


Synergie SWOT Analysis / TOWS Matrix

Services , Business Services


Zhengye Intl SWOT Analysis / TOWS Matrix

Basic Materials , Containers & Packaging