AccuForm: Ethical Leadership and Its Challenges in the Era of Globalization 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 AccuForm: Ethical Leadership and Its Challenges in the Era of Globalization case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. AccuForm: Ethical Leadership and Its Challenges in the Era of Globalization case study is a Harvard Business School (HBR) case study written by Claudia H. L. Woo, Amy Lau, Raymond Wong. The AccuForm: Ethical Leadership and Its Challenges in the Era of Globalization (referred as “Accuform Accuform's” 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, Motivating people.

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 AccuForm: Ethical Leadership and Its Challenges in the Era of Globalization Case Study

AccuForm, a German-Hong Kong joint venture specializing in the production of chemical coatings for application to garments, is confronted with a situation where an unauthorized Chinese manufacturer had stolen one of AccuForm's experimental coatings, applied it to their own brand of clothing, and sold it to the public as an AccuForm product. The product had caused allergic reactions in some children, and the media had widely reported the incident. It was later discovered there was more to the situation than stolen coating, as some staff were found to have engaged in money laundering, misappropriation of company assets, acceptance of illegitimate rebates, and bribes. The general manager of AccuForm, in addition to having to deal with the media, also had to find a way to resolve the differences in business practices between the company's German and Hong Kong parents, which are thought to have been partially responsible for the incident, as well as rebuild staff morale and customers' confidence in AccuForm's products. Illustrates how differences in company cultures can create difficulty for management, and what are formulas for success in one country may be guarantees of failure in another.

Case Authors : Claudia H. L. Woo, Amy Lau, Raymond Wong

Topic : Global Business

Related Areas : Ethics, Motivating people

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Calculating Net Present Value (NPV) at 6% for AccuForm: Ethical Leadership and Its Challenges in the Era of Globalization Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10029481)	-10029481	-	-
Year 1	3469042	-6560439	3469042	0.9434	3272681
Year 2	3965508	-2594931	7434550	0.89	3529288
Year 3	3942012	1347081	11376562	0.8396	3309789
Year 4	3249681	4596762	14626243	0.7921	2574052
TOTAL			14626243		12685810

The Net Present Value at 6% discount rate is 2656329

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. Net Present Value
2. Payback Period
3. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Accuform Accuform's shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Accuform Accuform's have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of AccuForm: Ethical Leadership and Its Challenges in the Era of Globalization

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 Accuform Accuform's 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 Accuform Accuform's 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	(10029481)	-10029481	-	-
Year 1	3469042	-6560439	3469042	0.8696	3016558
Year 2	3965508	-2594931	7434550	0.7561	2998494
Year 3	3942012	1347081	11376562	0.6575	2591937
Year 4	3249681	4596762	14626243	0.5718	1858016
TOTAL					10465005

The Net NPV after 4 years is 435524

(10465005 - 10029481 )

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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	(10029481)	-10029481	-	-
Year 1	3469042	-6560439	3469042	0.8333	2890868
Year 2	3965508	-2594931	7434550	0.6944	2753825
Year 3	3942012	1347081	11376562	0.5787	2281257
Year 4	3249681	4596762	14626243	0.4823	1567169
TOTAL					9493119

The Net NPV after 4 years is -536362

At 20% discount rate the NPV is negative (9493119 - 10029481 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Accuform Accuform's 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 Accuform Accuform's has a NPV value higher than Zero then finance managers at Accuform Accuform's 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 Accuform Accuform's, then the stock price of the Accuform Accuform's 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 Accuform Accuform's 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 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 can impact the cash flow of 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.

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 AccuForm: Ethical Leadership and Its Challenges in the Era of Globalization

References & Further Readings

Claudia H. L. Woo, Amy Lau, Raymond Wong (2018), "AccuForm: Ethical Leadership and Its Challenges in the Era of Globalization Harvard Business Review Case Study. Published by HBR Publications.