Airbus A3XX: Developing the World's Largest Commercial Jet (A) 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 Airbus A3XX: Developing the World's Largest Commercial Jet (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Airbus A3XX: Developing the World's Largest Commercial Jet (A) case study is a Harvard Business School (HBR) case study written by Benjamin C. Esty, Michael Kane. The Airbus A3XX: Developing the World's Largest Commercial Jet (A) (referred as “A3xx Airbus” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Competitive strategy, Costs, Financial analysis, Government, Marketing, Product development, Project management.

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 Airbus A3XX: Developing the World's Largest Commercial Jet (A) Case Study

In July 2000, Airbus Industries' supervisory board is on the verge of approving a $13 billion investment for the development of a new super jumbo jet known as the A3XX that would seat from 550 to 1,000 passengers. Having secured approximately 20 orders for the new jet, the board must decide whether there is sufficient long-term demand for the A3XX to justify the investment. At the time, Airbus was predicting that the market for very large aircraft (VLA), those seating more than 500 passengers, would exceed 1,500 aircraft over the next 20 years and would generate sales in excess of $350 billion. According to Airbus, it needed to sell 250 aircraft to break even and could sell as many as 750 aircraft over the next 20 years. This case explores the two sets of forecasts and asks students whether they would proceed with the launch given the size of the investment and the uncertainty in long-term demand.

Case Authors : Benjamin C. Esty, Michael Kane

Topic : Finance & Accounting

Related Areas : Competitive strategy, Costs, Financial analysis, Government, Marketing, Product development, Project management

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Calculating Net Present Value (NPV) at 6% for Airbus A3XX: Developing the World's Largest Commercial Jet (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10004687)	-10004687	-	-
Year 1	3460660	-6544027	3460660	0.9434	3264774
Year 2	3970504	-2573523	7431164	0.89	3533734
Year 3	3937039	1363516	11368203	0.8396	3305614
Year 4	3235000	4598516	14603203	0.7921	2562423
TOTAL			14603203		12666545

The Net Present Value at 6% discount rate is 2661858

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. Internal Rate of Return
2. Profitability Index
3. Net Present Value
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 A3xx Airbus 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. A3xx Airbus 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 Airbus A3XX: Developing the World's Largest Commercial Jet (A)

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 A3xx Airbus 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 A3xx Airbus 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	(10004687)	-10004687	-	-
Year 1	3460660	-6544027	3460660	0.8696	3009270
Year 2	3970504	-2573523	7431164	0.7561	3002271
Year 3	3937039	1363516	11368203	0.6575	2588667
Year 4	3235000	4598516	14603203	0.5718	1849622
TOTAL					10449830

The Net NPV after 4 years is 445143

(10449830 - 10004687 )

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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	(10004687)	-10004687	-	-
Year 1	3460660	-6544027	3460660	0.8333	2883883
Year 2	3970504	-2573523	7431164	0.6944	2757294
Year 3	3937039	1363516	11368203	0.5787	2278379
Year 4	3235000	4598516	14603203	0.4823	1560089
TOTAL					9479646

The Net NPV after 4 years is -525041

At 20% discount rate the NPV is negative (9479646 - 10004687 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of A3xx Airbus 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 A3xx Airbus has a NPV value higher than Zero then finance managers at A3xx Airbus 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 A3xx Airbus, then the stock price of the A3xx Airbus 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 A3xx Airbus 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 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.

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 Airbus A3XX: Developing the World's Largest Commercial Jet (A)

References & Further Readings

Benjamin C. Esty, Michael Kane (2018), "Airbus A3XX: Developing the World's Largest Commercial Jet (A) Harvard Business Review Case Study. Published by HBR Publications.