"Non-Globalization" of Innovation in the Semiconductor Industry 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 "Non-Globalization" of Innovation in the Semiconductor Industry case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. "Non-Globalization" of Innovation in the Semiconductor Industry case study is a Harvard Business School (HBR) case study written by Jeffrey T. MacHer, David C. Mowery, Alberto Di Minin. The "Non-Globalization" of Innovation in the Semiconductor Industry (referred as “Semiconductor Industry” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Financial markets, Globalization, Innovation, Manufacturing, Market research.

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 "Non-Globalization" of Innovation in the Semiconductor Industry Case Study

The global semiconductor industry is undergoing several forms of structural change simultaneously. The structure of market demand is shifting from one dominated by personal computers to a more diverse array of heterogeneous niches, largely resulting from global diffusion of the Internet and wireless communications applications. The structure of manufacturing activities is shifting from one dominated by "integrated device manufacturers" (IDMs), which both design and manufacture semiconductor components, to one characterized by vertical specialization, where many firms specialize in either design and marketing ("fabless" firms) or manufacturing ("foundries"). Finally, market demand and technical expertise are growing in geographic regions (e.g., Malaysia, Singapore, and the People's Republic of China) that formerly were much less prominent actors in the global industry. In the face of such far-reaching structural change in the industry, it is surprising that most indicators of the "globalization" of innovation-related activities in the U.S. semiconductor industry--ranging from publicly available data on the share of industry-funded R&D that is performed offshore to the location of inventive activity associated with patenting by U.S. firms--indicate only modest offshore movement in key innovation-related activities. To a surprising extent, this evidence suggests that much of the innovation process in this global industry remains "non-globalized."

Case Authors : Jeffrey T. MacHer, David C. Mowery, Alberto Di Minin

Topic : Global Business

Related Areas : Financial markets, Globalization, Innovation, Manufacturing, Market research

Calculating Net Present Value (NPV) at 6% for "Non-Globalization" of Innovation in the Semiconductor Industry Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10013686) -10013686 - -
Year 1 3460431 -6553255 3460431 0.9434 3264558
Year 2 3955714 -2597541 7416145 0.89 3520571
Year 3 3954974 1357433 11371119 0.8396 3320672
Year 4 3223322 4580755 14594441 0.7921 2553173
TOTAL 14594441 12658974

The Net Present Value at 6% discount rate is 2645288

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. Net Present Value
3. Payback Period
4. Internal Rate of Return

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 Semiconductor Industry 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. Semiconductor Industry 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 "Non-Globalization" of Innovation in the Semiconductor Industry

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 Semiconductor Industry 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 Semiconductor Industry 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 %
Cash Flows
Year 0 (10013686) -10013686 - -
Year 1 3460431 -6553255 3460431 0.8696 3009070
Year 2 3955714 -2597541 7416145 0.7561 2991088
Year 3 3954974 1357433 11371119 0.6575 2600460
Year 4 3223322 4580755 14594441 0.5718 1842945
TOTAL 10443563

The Net NPV after 4 years is 429877

(10443563 - 10013686 )

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 %
Cash Flows
Year 0 (10013686) -10013686 - -
Year 1 3460431 -6553255 3460431 0.8333 2883693
Year 2 3955714 -2597541 7416145 0.6944 2747024
Year 3 3954974 1357433 11371119 0.5787 2288758
Year 4 3223322 4580755 14594441 0.4823 1554457
TOTAL 9473931

The Net NPV after 4 years is -539755

At 20% discount rate the NPV is negative (9473931 - 10013686 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Semiconductor Industry 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 Semiconductor Industry has a NPV value higher than Zero then finance managers at Semiconductor Industry 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 Semiconductor Industry, then the stock price of the Semiconductor Industry 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 Semiconductor Industry 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.

Understanding of risks involved in the project.

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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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

Jeffrey T. MacHer, David C. Mowery, Alberto Di Minin (2018), ""Non-Globalization" of Innovation in the Semiconductor Industry Harvard Business Review Case Study. Published by HBR Publications.