MedMira Laboratories: The U.S. OTC Decision 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 MedMira Laboratories: The U.S. OTC Decision case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. MedMira Laboratories: The U.S. OTC Decision case study is a Harvard Business School (HBR) case study written by Melissa Whellams, Julia Sagebien. The MedMira Laboratories: The U.S. OTC Decision (referred as “Medmira Otc” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Marketing, Social responsibility.

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 MedMira Laboratories: The U.S. OTC Decision Case Study

In December 2005, the vice-president of global sales and marketing for MedMira Laboratories in Halifax, Nova Scotia, has to decide whether to enter the over-the-counter (OTC) HIV testing market in the United States, if the company receives approval from the U.S. Food and Drug Administration. Entry into this market could potentially open the door to OTC sales of other infectious disease tests that MedMira could develop with its current technology. Not entering the market could result in shareholder disapproval and a significant missed opportunity. With the exception of China, the majority of the company's tests have been sold to hospitals and laboratories, therefore, U.S. OTC sales would require the development of new marketing and distribution expertise. It would also be a very expensive undertaking for such a small company with accumulated losses. If MedMira decides to enter the market, the vice-president of global sales and marketing would need to determine whether to go it alone or partner with Home Access Health Corporation, a Chicago-based company, which has the only FDA-approved at-home test system on market. There are also a number of ethical concerns surrounding at-home testing that would need to be addressed.

Case Authors : Melissa Whellams, Julia Sagebien

Topic : Global Business

Related Areas : Marketing, Social responsibility

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Calculating Net Present Value (NPV) at 6% for MedMira Laboratories: The U.S. OTC Decision Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10017369)	-10017369	-	-
Year 1	3447673	-6569696	3447673	0.9434	3252522
Year 2	3969086	-2600610	7416759	0.89	3532472
Year 3	3972805	1372195	11389564	0.8396	3335644
Year 4	3234349	4606544	14623913	0.7921	2561907
TOTAL			14623913		12682545

The Net Present Value at 6% discount rate is 2665176

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. 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 Medmira Otc 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. Medmira Otc 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 MedMira Laboratories: The U.S. OTC Decision

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 Medmira Otc 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 Medmira Otc 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	(10017369)	-10017369	-	-
Year 1	3447673	-6569696	3447673	0.8696	2997977
Year 2	3969086	-2600610	7416759	0.7561	3001199
Year 3	3972805	1372195	11389564	0.6575	2612184
Year 4	3234349	4606544	14623913	0.5718	1849250
TOTAL					10460609

The Net NPV after 4 years is 443240

(10460609 - 10017369 )

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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	(10017369)	-10017369	-	-
Year 1	3447673	-6569696	3447673	0.8333	2873061
Year 2	3969086	-2600610	7416759	0.6944	2756310
Year 3	3972805	1372195	11389564	0.5787	2299077
Year 4	3234349	4606544	14623913	0.4823	1559775
TOTAL					9488222

The Net NPV after 4 years is -529147

At 20% discount rate the NPV is negative (9488222 - 10017369 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Medmira Otc 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 Medmira Otc has a NPV value higher than Zero then finance managers at Medmira Otc 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 Medmira Otc, then the stock price of the Medmira Otc 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 Medmira Otc 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 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.

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 MedMira Laboratories: The U.S. OTC Decision

References & Further Readings

Melissa Whellams, Julia Sagebien (2018), "MedMira Laboratories: The U.S. OTC Decision Harvard Business Review Case Study. Published by HBR Publications.