Gold Peak Electronics: R&D Globalization from East to West 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 Gold Peak Electronics: R&D Globalization from East to West case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Gold Peak Electronics: R&D Globalization from East to West case study is a Harvard Business School (HBR) case study written by Kuldeep Kumar, Maya Kumar. The Gold Peak Electronics: R&D Globalization from East to West (referred as “Gpe Acquisitions” 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 management, Globalization, Government, Human resource management, Internet, Mergers & acquisitions, Operations management, Research & development.

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 Gold Peak Electronics: R&D Globalization from East to West Case Study

Globalization has prompted a new trend of cross-border acquisitions from the East to the West. Fueled by non-traditional motivations, Asian companies are acquiring respected and well-established Western brands, technology, assets and knowledge, and through these acquisitions gaining access to developed markets and talent pools. One such company, Gold Peak Electronics ("GPE"), is a multinational corporation that is among an elite group of Hong Kong electronics companies that design, manufacture and sell premium professional and home electronics products. Acquiring two high-end British premium loudspeaker companies in 1992-KEF Audio and Celestion International-has allowed GPE to take advantage of these companies' well established intellectual assets and R&D capabilities. However, cross-border acquisitions such as these are complicated, requiring companies to take into consideration differing regulations, national cultures, political factors, employee mindsets and work cultures. The acquiring company has also had to deal with human resource issues in its acquisitions, including handling work distribution and promoting employees' sense of job security. Although several years have passed since the acquisition, collaboration between GPEs various R&D sites in the UK, Hong Kong, and China is still not optimal. How can GPE successfully overcome the distances between these locations and promote innovative collaboration between its dispersed R&D sites? Was growth by acquisition of Western companies the best strategy for GPE's growth? This case illustrates opportunities and challenges for global R&D and virtual collaboration across geographic and cultural distances. This case also familiarizes students with the unique challenges in acquisitions of Western companies by Eastern companies, including human resources management and how the process of innovation and innovative thinking differs across countries.

Case Authors : Kuldeep Kumar, Maya Kumar

Topic : Global Business

Related Areas : Financial management, Globalization, Government, Human resource management, Internet, Mergers & acquisitions, Operations management, Research & development

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Calculating Net Present Value (NPV) at 6% for Gold Peak Electronics: R&D Globalization from East to West Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10028456)	-10028456	-	-
Year 1	3466929	-6561527	3466929	0.9434	3270688
Year 2	3972262	-2589265	7439191	0.89	3535299
Year 3	3951715	1362450	11390906	0.8396	3317936
Year 4	3222256	4584706	14613162	0.7921	2552329
TOTAL			14613162		12676251

The Net Present Value at 6% discount rate is 2647795

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

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 Gpe Acquisitions 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. Gpe Acquisitions 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 Gold Peak Electronics: R&D Globalization from East to West

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 Gpe Acquisitions 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 Gpe Acquisitions 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	(10028456)	-10028456	-	-
Year 1	3466929	-6561527	3466929	0.8696	3014721
Year 2	3972262	-2589265	7439191	0.7561	3003601
Year 3	3951715	1362450	11390906	0.6575	2598317
Year 4	3222256	4584706	14613162	0.5718	1842335
TOTAL					10458974

The Net NPV after 4 years is 430518

(10458974 - 10028456 )

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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	(10028456)	-10028456	-	-
Year 1	3466929	-6561527	3466929	0.8333	2889108
Year 2	3972262	-2589265	7439191	0.6944	2758515
Year 3	3951715	1362450	11390906	0.5787	2286872
Year 4	3222256	4584706	14613162	0.4823	1553943
TOTAL					9488438

The Net NPV after 4 years is -540018

At 20% discount rate the NPV is negative (9488438 - 10028456 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Gpe Acquisitions 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 Gpe Acquisitions has a NPV value higher than Zero then finance managers at Gpe Acquisitions 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 Gpe Acquisitions, then the stock price of the Gpe Acquisitions 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 Gpe Acquisitions 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.

What will be a multi year spillover effect of various taxation regulations.

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.

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 Gold Peak Electronics: R&D Globalization from East to West

References & Further Readings

Kuldeep Kumar, Maya Kumar (2018), "Gold Peak Electronics: R&D Globalization from East to West Harvard Business Review Case Study. Published by HBR Publications.