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Burroughs Wellcome and AZT (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 Burroughs Wellcome and AZT (A) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Burroughs Wellcome and AZT (A) case study is a Harvard Business School (HBR) case study written by Willis Emmons, Ashok Nimgade. The Burroughs Wellcome and AZT (A) (referred as “Wellcome Azt” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Ethics, Government, Pricing, Public relations, Research & development, Risk 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




Case Description of Burroughs Wellcome and AZT (A) Case Study


This case is accompanied by a Video Short that can be shown in class or included in a digital coursepack. Instructors should consider the timing of making the video available to students, as it may reveal key case details.Burroughs Wellcome Co., developer of AZT, the first drug approved by the U.S. Food and Drug Administration for the treatment of Acquired Immune Deficiency Syndrome (AIDS), finds itself under siege in September 1989 by AIDS activists and various segments of the U.S. government. In spite of repeated demands over the previous two years to lower the price of AZT (trademarked Retrovie), Burroughs Wellcome and its parent company, London-based Wellcome PLC, have refused, claiming that the $6,300 annual (wholesale) cost of the drug per person is justified, based on high research, development, production, and other costs associated with the drug. The firm's opponents accuse it of using an existing chemical compound, ample government research assistance, and a cooperative regulatory system to gain a monopoly on the only approved treatment available for people with AIDS. The case gives students the opportunity to explore the economics and regulation of the pharmaceutical industry, wrestle with the ethics of drug pricing, and analyze the formulation of public relations strategies on the part of both private companies and activist groups in the age of AIDS.


Case Authors : Willis Emmons, Ashok Nimgade

Topic : Global Business

Related Areas : Ethics, Government, Pricing, Public relations, Research & development, Risk management




Calculating Net Present Value (NPV) at 6% for Burroughs Wellcome and AZT (A) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10020435) -10020435 - -
Year 1 3470254 -6550181 3470254 0.9434 3273825
Year 2 3957722 -2592459 7427976 0.89 3522358
Year 3 3943782 1351323 11371758 0.8396 3311275
Year 4 3224807 4576130 14596565 0.7921 2554349
TOTAL 14596565 12661808


The Net Present Value at 6% discount rate is 2641373

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. 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. Timing of the expected cash flows – stockholders of Wellcome Azt 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. Wellcome Azt 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 Burroughs Wellcome and AZT (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 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 Wellcome Azt 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 Wellcome Azt 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 (10020435) -10020435 - -
Year 1 3470254 -6550181 3470254 0.8696 3017612
Year 2 3957722 -2592459 7427976 0.7561 2992606
Year 3 3943782 1351323 11371758 0.6575 2593101
Year 4 3224807 4576130 14596565 0.5718 1843794
TOTAL 10447113


The Net NPV after 4 years is 426678

(10447113 - 10020435 )






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 (10020435) -10020435 - -
Year 1 3470254 -6550181 3470254 0.8333 2891878
Year 2 3957722 -2592459 7427976 0.6944 2748418
Year 3 3943782 1351323 11371758 0.5787 2282281
Year 4 3224807 4576130 14596565 0.4823 1555173
TOTAL 9477751


The Net NPV after 4 years is -542684

At 20% discount rate the NPV is negative (9477751 - 10020435 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Wellcome Azt 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 Wellcome Azt has a NPV value higher than Zero then finance managers at Wellcome Azt 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 Wellcome Azt, then the stock price of the Wellcome Azt 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 Wellcome Azt 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.

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

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.




References & Further Readings

Willis Emmons, Ashok Nimgade (2018), "Burroughs Wellcome and AZT (A) Harvard Business Review Case Study. Published by HBR Publications.