Collision Course: Selling European High Performance Motorcycles in Japan 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 Collision Course: Selling European High Performance Motorcycles in Japan case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Collision Course: Selling European High Performance Motorcycles in Japan case study is a Harvard Business School (HBR) case study written by Jeff Hicks, Derek Lehmberg. The Collision Course: Selling European High Performance Motorcycles in Japan (referred as “Tommasi Motorcycles” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Manufacturing.

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 Collision Course: Selling European High Performance Motorcycles in Japan Case Study

In 2006, the Japan subsidiary of Tommasi Motorcycles, an Italian manufacturer of high-end motorcycles, was implementing a new customer data application to help its motorcycle dealerships increase the effectiveness of their sales and marketing activities. Horizon LLP, a consulting firm, was Tommasi's global implementation partner for the application. To identify any dealer concerns regarding the new system, Tommasi Japan had brought in additional consultants from Horizon to conduct a series of interviews with the dealers. As the consultants soon discovered, the dealers' concerns with Tomassi went far beyond the new application. An unannounced visit by an influential dealer set all the players on a collision course, and soon exposed their widely differing views and a number of fundamental problems in the relationship between Tommasi Motorcycles Japan and its dealer network.The case begins with a series of separate dialogues involving the director of sales and marketing, Nobu Katoh; the expat president of Tommasi Motorcycles Japan, Fambio Bonardi; Koji Saito, an influential owner of multiple dealerships; and two consultants from Horizon, both of whom are non-Japanese. When they meet in the board room of Tommasi Motorcycles Japan, the ensuing conversation reveals a number of issues: opportunistic behaviour by the bilingual Katoh, who plays the role of translator - and also gatekeeper - between the dealers and Tommasi's Japanese National Office by limiting, filtering and shaping communications in both directions; a limited understanding of local market conditions by expat Tommasi management who rotate in and out of their positions every three years; frustration on the part of business-savvy dealers; and naivetA© on the part of the consultants, who did not see the social hierarchies at work, nor realize that their cultural and language fluency, which had in past projects always been an asset, could also be a threat.

Case Authors : Jeff Hicks, Derek Lehmberg

Topic : Global Business

Related Areas : Manufacturing

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Calculating Net Present Value (NPV) at 6% for Collision Course: Selling European High Performance Motorcycles in Japan Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10011232)	-10011232	-	-
Year 1	3462555	-6548677	3462555	0.9434	3266561
Year 2	3960829	-2587848	7423384	0.89	3525124
Year 3	3943441	1355593	11366825	0.8396	3310989
Year 4	3237930	4593523	14604755	0.7921	2564744
TOTAL			14604755		12667418

The Net Present Value at 6% discount rate is 2656186

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. 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 Tommasi Motorcycles 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. Tommasi Motorcycles 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 Collision Course: Selling European High Performance Motorcycles in Japan

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 Tommasi Motorcycles 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 Tommasi Motorcycles 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	(10011232)	-10011232	-	-
Year 1	3462555	-6548677	3462555	0.8696	3010917
Year 2	3960829	-2587848	7423384	0.7561	2994956
Year 3	3943441	1355593	11366825	0.6575	2592876
Year 4	3237930	4593523	14604755	0.5718	1851297
TOTAL					10450047

The Net NPV after 4 years is 438815

(10450047 - 10011232 )

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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	(10011232)	-10011232	-	-
Year 1	3462555	-6548677	3462555	0.8333	2885463
Year 2	3960829	-2587848	7423384	0.6944	2750576
Year 3	3943441	1355593	11366825	0.5787	2282084
Year 4	3237930	4593523	14604755	0.4823	1561502
TOTAL					9479624

The Net NPV after 4 years is -531608

At 20% discount rate the NPV is negative (9479624 - 10011232 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Tommasi Motorcycles 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 Tommasi Motorcycles has a NPV value higher than Zero then finance managers at Tommasi Motorcycles 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 Tommasi Motorcycles, then the stock price of the Tommasi Motorcycles 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 Tommasi Motorcycles 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 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 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.

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 Collision Course: Selling European High Performance Motorcycles in Japan

References & Further Readings

Jeff Hicks, Derek Lehmberg (2018), "Collision Course: Selling European High Performance Motorcycles in Japan Harvard Business Review Case Study. Published by HBR Publications.