What do Firms From Transition Economies Want From Their Strategic Alliance Partners? 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 Firms From Transition Economies Want From Their Strategic Alliance Partners? case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. What do Firms From Transition Economies Want From Their Strategic Alliance Partners? case study is a Harvard Business School (HBR) case study written by Michael N. Young, David Ahlstrom, Garry D. Bruton, Yuri Rubanik. The What do Firms From Transition Economies Want From Their Strategic Alliance Partners? (referred as “Economies Transition” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, International business, Joint ventures.

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 What do Firms From Transition Economies Want From Their Strategic Alliance Partners? Case Study

A financial system engaged in active transition from central planning to free market may be dubbed a transition economy. On today's global landscape, there are several important transition economies, all at various stages of transition and with differing degrees of success. Yet, much is not known about this important sector of the world economy. As outside enterprises seek alliances with firms from transition economies, it is important to know what these firms want from alliance partners. To learn more, we conducted a study interviewing managers of private firms from the two largest and most strategically important transition economies: China and Russia. We found that while Chinese and Russian firms often hope for some of the same things as their counterparts in mature economies as regards alliances, they are also interested in other things not normally associated with alliances: political influence, relief from paying bribes, and protection from extortion or even violence. Moreover, we discovered that because of differing institutional conditions in the two countries, Chinese firms are not always looking for the same things from alliances as are Russian firms-in spite of surface similarities between the two economies. Based on these findings, we provide guidelines for firms seeking alliance partners in transition economies, to assist them in determining if an alliance is right for them and planning accordingly.

Case Authors : Michael N. Young, David Ahlstrom, Garry D. Bruton, Yuri Rubanik

Topic : Global Business

Related Areas : International business, Joint ventures

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Calculating Net Present Value (NPV) at 6% for What do Firms From Transition Economies Want From Their Strategic Alliance Partners? Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10000037)	-10000037	-	-
Year 1	3460705	-6539332	3460705	0.9434	3264816
Year 2	3963124	-2576208	7423829	0.89	3527166
Year 3	3939301	1363093	11363130	0.8396	3307513
Year 4	3240484	4603577	14603614	0.7921	2566767
TOTAL			14603614		12666262

The Net Present Value at 6% discount rate is 2666225

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. 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 Economies Transition 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. Economies Transition 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 What do Firms From Transition Economies Want From Their Strategic Alliance Partners?

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 Economies Transition 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 Economies Transition 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	(10000037)	-10000037	-	-
Year 1	3460705	-6539332	3460705	0.8696	3009309
Year 2	3963124	-2576208	7423829	0.7561	2996691
Year 3	3939301	1363093	11363130	0.6575	2590154
Year 4	3240484	4603577	14603614	0.5718	1852757
TOTAL					10448911

The Net NPV after 4 years is 448874

(10448911 - 10000037 )

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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	(10000037)	-10000037	-	-
Year 1	3460705	-6539332	3460705	0.8333	2883921
Year 2	3963124	-2576208	7423829	0.6944	2752169
Year 3	3939301	1363093	11363130	0.5787	2279688
Year 4	3240484	4603577	14603614	0.4823	1562733
TOTAL					9478512

The Net NPV after 4 years is -521525

At 20% discount rate the NPV is negative (9478512 - 10000037 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Economies Transition 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 Economies Transition has a NPV value higher than Zero then finance managers at Economies Transition 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 Economies Transition, then the stock price of the Economies Transition 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 Economies Transition 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 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.

Understanding of risks involved in the project.

What can impact the cash flow of the project.

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 What do Firms From Transition Economies Want From Their Strategic Alliance Partners?

References & Further Readings

Michael N. Young, David Ahlstrom, Garry D. Bruton, Yuri Rubanik (2018), "What do Firms From Transition Economies Want From Their Strategic Alliance Partners? Harvard Business Review Case Study. Published by HBR Publications.