Singapore Airlines in the 90s 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 Singapore Airlines in the 90s case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Singapore Airlines in the 90s case study is a Harvard Business School (HBR) case study written by Bruce McKern, David Lloyd. The Singapore Airlines in the 90s (referred as “Sia Singapore” 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, Leadership, National competitiveness, Strategy execution.

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 Singapore Airlines in the 90s Case Study

This case is available in only hard copy format (HBP does not have digital distribution rights to the content). As a result, a digital Educator Copy of the case is not available through this web site.Focuses on how a firm can develop organizational competencies that are difficult for others to imitate. Illustrates how a firm can create and maintain dynamic competitive advantage in an industry in which the external forces that make for success seem to be relatively easy to observe. In conjunction with an industry note on the airline industry, the case is useful for discussion about alliances. Also provides a basis for discussing issues of managerial culture and the question of how to integrate personnel from North America and Europe into the culture of a successful Asian company. Describes the external and internal challenges facing Singapore Airlines (SIA) at the end of 1990. The country environment of Singapore is briefly reviewed, focusing on its history, culture, and its political and economic environment. The development of SIA is traced with reference to Singapore's history and national policies. Provides a detailed description of SIA's strategy and its implementation. Service, fleet, cost, and ownership issues frame the detail provided on the processes of selecting and training people, the quality system, fleet management, and control of costs.

Case Authors : Bruce McKern, David Lloyd

Topic : Global Business

Related Areas : International business, Leadership, National competitiveness, Strategy execution

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Calculating Net Present Value (NPV) at 6% for Singapore Airlines in the 90s Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10029519)	-10029519	-	-
Year 1	3458585	-6570934	3458585	0.9434	3262816
Year 2	3959860	-2611074	7418445	0.89	3524261
Year 3	3966833	1355759	11385278	0.8396	3330629
Year 4	3242356	4598115	14627634	0.7921	2568250
TOTAL			14627634		12685956

The Net Present Value at 6% discount rate is 2656437

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. Net Present Value
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. Sia Singapore 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 Sia Singapore 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 Singapore Airlines in the 90s

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 Sia Singapore 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 Sia Singapore 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	(10029519)	-10029519	-	-
Year 1	3458585	-6570934	3458585	0.8696	3007465
Year 2	3959860	-2611074	7418445	0.7561	2994223
Year 3	3966833	1355759	11385278	0.6575	2608257
Year 4	3242356	4598115	14627634	0.5718	1853828
TOTAL					10463773

The Net NPV after 4 years is 434254

(10463773 - 10029519 )

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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	(10029519)	-10029519	-	-
Year 1	3458585	-6570934	3458585	0.8333	2882154
Year 2	3959860	-2611074	7418445	0.6944	2749903
Year 3	3966833	1355759	11385278	0.5787	2295621
Year 4	3242356	4598115	14627634	0.4823	1563636
TOTAL					9491314

The Net NPV after 4 years is -538205

At 20% discount rate the NPV is negative (9491314 - 10029519 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Sia Singapore 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 Sia Singapore has a NPV value higher than Zero then finance managers at Sia Singapore 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 Sia Singapore, then the stock price of the Sia Singapore 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 Sia Singapore 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 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.

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.

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Negotiation Strategy of Singapore Airlines in the 90s

References & Further Readings

Bruce McKern, David Lloyd (2018), "Singapore Airlines in the 90s Harvard Business Review Case Study. Published by HBR Publications.