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Huawei: Cisco's Chinese Challenger 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 Huawei: Cisco's Chinese Challenger case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Huawei: Cisco's Chinese Challenger case study is a Harvard Business School (HBR) case study written by Ali Farhoomand, Phoebe Ho. The Huawei: Cisco's Chinese Challenger (referred as “Huawei Low” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Growth strategy.

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 Huawei: Cisco's Chinese Challenger Case Study


Huawei was China's largest telecommunication equipment provider. It boasted annual revenue of US$6.7 billion in 2005, 60% of which came from international sales. Globally, Huawei had a strong position in the market for low-end routers and switches, offering products that were 40% cheaper than its competitors. However, unlike the threat from most Chinese companies, Huawei's threat came not from low-cost manufacturing but from low-cost engineering. Can Huawei leverage its strengths to climb up the technology value chain, replicating its success with low-end telecom networking in high-technology products and services? Can it build a global brand?


Case Authors : Ali Farhoomand, Phoebe Ho

Topic : Global Business

Related Areas : Growth strategy




Calculating Net Present Value (NPV) at 6% for Huawei: Cisco's Chinese Challenger Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10028154) -10028154 - -
Year 1 3457512 -6570642 3457512 0.9434 3261804
Year 2 3955657 -2614985 7413169 0.89 3520521
Year 3 3962027 1347042 11375196 0.8396 3326594
Year 4 3233322 4580364 14608518 0.7921 2561094
TOTAL 14608518 12670013


The Net Present Value at 6% discount rate is 2641859

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

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 Huawei Low 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. Huawei Low 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 Huawei: Cisco's Chinese Challenger

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 Huawei Low 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 Huawei Low 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 (10028154) -10028154 - -
Year 1 3457512 -6570642 3457512 0.8696 3006532
Year 2 3955657 -2614985 7413169 0.7561 2991045
Year 3 3962027 1347042 11375196 0.6575 2605097
Year 4 3233322 4580364 14608518 0.5718 1848662
TOTAL 10451337


The Net NPV after 4 years is 423183

(10451337 - 10028154 )






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 (10028154) -10028154 - -
Year 1 3457512 -6570642 3457512 0.8333 2881260
Year 2 3955657 -2614985 7413169 0.6944 2746984
Year 3 3962027 1347042 11375196 0.5787 2292840
Year 4 3233322 4580364 14608518 0.4823 1559280
TOTAL 9480363


The Net NPV after 4 years is -547791

At 20% discount rate the NPV is negative (9480363 - 10028154 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Huawei Low 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 Huawei Low has a NPV value higher than Zero then finance managers at Huawei Low 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 Huawei Low, then the stock price of the Huawei Low 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 Huawei Low 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.

Understanding of risks involved in 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 will be a multi year spillover effect of various taxation regulations.

What can impact the cash flow of 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.




References & Further Readings

Ali Farhoomand, Phoebe Ho (2018), "Huawei: Cisco's Chinese Challenger Harvard Business Review Case Study. Published by HBR Publications.