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Mind Over Matter? A Case for Artificial Intelligence 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 Mind Over Matter? A Case for Artificial Intelligence case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Mind Over Matter? A Case for Artificial Intelligence case study is a Harvard Business School (HBR) case study written by Philip Parker, Nao Maeda. The Mind Over Matter? A Case for Artificial Intelligence (referred as “Artificial Intelligence” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Technology.

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 Mind Over Matter? A Case for Artificial Intelligence Case Study


There are few industries in which the effects of technological innovation be seen as clearly as they can in the healthcare industry. Developments in devices, services and networks are in turn creating even more opportunities and innovation. This case looks specifically at developments in Artificial Intelligence technologies, and the impact these might have on the treatment of certain diseases. With a particular focus on the treatment of diabetes, the case looks at the market potential of such innovations and the challenges the industry might expect to encounter going forward.


Case Authors : Philip Parker, Nao Maeda

Topic : Global Business

Related Areas : Technology




Calculating Net Present Value (NPV) at 6% for Mind Over Matter? A Case for Artificial Intelligence Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10010798) -10010798 - -
Year 1 3454754 -6556044 3454754 0.9434 3259202
Year 2 3979671 -2576373 7434425 0.89 3541893
Year 3 3970439 1394066 11404864 0.8396 3333657
Year 4 3237009 4631075 14641873 0.7921 2564014
TOTAL 14641873 12698766




The Net Present Value at 6% discount rate is 2687968

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. Profitability Index
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. Timing of the expected cash flows – stockholders of Artificial Intelligence 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. Artificial Intelligence 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 Mind Over Matter? A Case for Artificial Intelligence

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 Global Business 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 Artificial Intelligence 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 Artificial Intelligence 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 (10010798) -10010798 - -
Year 1 3454754 -6556044 3454754 0.8696 3004134
Year 2 3979671 -2576373 7434425 0.7561 3009203
Year 3 3970439 1394066 11404864 0.6575 2610628
Year 4 3237009 4631075 14641873 0.5718 1850770
TOTAL 10474735


The Net NPV after 4 years is 463937

(10474735 - 10010798 )








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 (10010798) -10010798 - -
Year 1 3454754 -6556044 3454754 0.8333 2878962
Year 2 3979671 -2576373 7434425 0.6944 2763660
Year 3 3970439 1394066 11404864 0.5787 2297708
Year 4 3237009 4631075 14641873 0.4823 1561058
TOTAL 9501387


The Net NPV after 4 years is -509411

At 20% discount rate the NPV is negative (9501387 - 10010798 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Artificial Intelligence 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 Artificial Intelligence has a NPV value higher than Zero then finance managers at Artificial Intelligence 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 Artificial Intelligence, then the stock price of the Artificial Intelligence 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 Artificial Intelligence 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 can impact the cash flow of 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.

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 Mind Over Matter? A Case for Artificial Intelligence

References & Further Readings

Philip Parker, Nao Maeda (2018), "Mind Over Matter? A Case for Artificial Intelligence Harvard Business Review Case Study. Published by HBR Publications.


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