What do We Make of Japan? Myths and Realities 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 What do We Make of Japan? Myths and Realities case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. What do We Make of Japan? Myths and Realities case study is a Harvard Business School (HBR) case study written by Derek Lehmberg, Charles Dhanaraj, Akie Funai. The What do We Make of Japan? Myths and Realities (referred as “Japan Myths” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, .

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 What do We Make of Japan? Myths and Realities Case Study

The disastrous events of 2011--an earthquake and a nuclear accident, a major accounting scandal at a well-known company, and an unusual current account deficit--have brought Japan back into the international news. Although China and other countries in Asia have grown faster and gained greater attention in the last decade, Japan continues to be an important business player. Japan has the world's third-largest economy and is home to many major corporations, leading-edge technology, operational knowhow, and a strong currency. While much about Japan seems familiar, many of our beliefs about the country remain frozen in the early 1990s, when Japanese management was a hot topic and Japanese businesses appeared invincible. Japan has changed much since then, however, and deserves an updated understanding. In this article, we identify six commonly held myths about Japan, present corresponding realities, and discuss recent developments and implications for managers.

Case Authors : Derek Lehmberg, Charles Dhanaraj, Akie Funai

Topic : Global Business

Related Areas :

Calculating Net Present Value (NPV) at 6% for What do We Make of Japan? Myths and Realities Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10025239) -10025239 - -
Year 1 3461755 -6563484 3461755 0.9434 3265807
Year 2 3970261 -2593223 7432016 0.89 3533518
Year 3 3975580 1382357 11407596 0.8396 3337974
Year 4 3243576 4625933 14651172 0.7921 2569216
TOTAL 14651172 12706514

The Net Present Value at 6% discount rate is 2681275

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

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 Japan Myths 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. Japan Myths 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 What do We Make of Japan? Myths and Realities

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 Japan Myths 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 Japan Myths 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 (10025239) -10025239 - -
Year 1 3461755 -6563484 3461755 0.8696 3010222
Year 2 3970261 -2593223 7432016 0.7561 3002088
Year 3 3975580 1382357 11407596 0.6575 2614008
Year 4 3243576 4625933 14651172 0.5718 1854525
TOTAL 10480843

The Net NPV after 4 years is 455604

(10480843 - 10025239 )

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 (10025239) -10025239 - -
Year 1 3461755 -6563484 3461755 0.8333 2884796
Year 2 3970261 -2593223 7432016 0.6944 2757126
Year 3 3975580 1382357 11407596 0.5787 2300683
Year 4 3243576 4625933 14651172 0.4823 1564225
TOTAL 9506829

The Net NPV after 4 years is -518410

At 20% discount rate the NPV is negative (9506829 - 10025239 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Japan Myths 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 Japan Myths has a NPV value higher than Zero then finance managers at Japan Myths 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 Japan Myths, then the stock price of the Japan Myths 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 Japan Myths 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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.

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

Derek Lehmberg, Charles Dhanaraj, Akie Funai (2018), "What do We Make of Japan? Myths and Realities Harvard Business Review Case Study. Published by HBR Publications.