Quickturn's Acquisition of SpeedSim (B): "Doomed from the Start" 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 Quickturn's Acquisition of SpeedSim (B): "Doomed from the Start" case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Quickturn's Acquisition of SpeedSim (B): "Doomed from the Start" case study is a Harvard Business School (HBR) case study written by Naeem Zafar. The Quickturn's Acquisition of SpeedSim (B): "Doomed from the Start" (referred as “Speedsim Acquisition” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Venture capital.

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 Quickturn's Acquisition of SpeedSim (B): "Doomed from the Start" Case Study

Supplement to case B5661. The SpeedSim case study focuses on how mergers and acquisitions work in startup and entrepreneurial environments. It describes how an intelligent East Coast engineer built an extremely frugal company with a goal for acquisition and how the SpeedSim team masterfully executed and maximized their return by starting, growing, and selling a company. The case analyzes the process of how small companies position themselves to be acquired and how an acquirer assesses a company. The case can be used for mergers and acquisition and exit discussions, as well as for culture and organizational behavior discussions for entrepreneurship curriculums. Please note: This case also has an (A) supplement available. The A case discusses how SpeedSim was built and what process they went through to get acquired. The B case addresses what happened after the acquisition and deals with the perspectives of the players and the challenges of the integration. Students are asked to evaluate how a company should go about establishing itself to be acquired and what decisions should be made in the earlier days of the startup. Students will also discuss how to create a successful acquisition and what factors contribute to the success of such an acquisition.

Case Authors : Naeem Zafar

Topic : Innovation & Entrepreneurship

Related Areas : Venture capital

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Calculating Net Present Value (NPV) at 6% for Quickturn's Acquisition of SpeedSim (B): "Doomed from the Start" Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10001646)	-10001646	-	-
Year 1	3464091	-6537555	3464091	0.9434	3268010
Year 2	3960038	-2577517	7424129	0.89	3524420
Year 3	3961315	1383798	11385444	0.8396	3325996
Year 4	3237522	4621320	14622966	0.7921	2564421
TOTAL			14622966		12682847

The Net Present Value at 6% discount rate is 2681201

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. Internal Rate of Return
3. Profitability Index
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 Speedsim Acquisition 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. Speedsim Acquisition 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 Quickturn's Acquisition of SpeedSim (B): "Doomed from the Start"

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 Innovation & Entrepreneurship 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 Speedsim Acquisition 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 Speedsim Acquisition 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	(10001646)	-10001646	-	-
Year 1	3464091	-6537555	3464091	0.8696	3012253
Year 2	3960038	-2577517	7424129	0.7561	2994358
Year 3	3961315	1383798	11385444	0.6575	2604629
Year 4	3237522	4621320	14622966	0.5718	1851064
TOTAL					10462303

The Net NPV after 4 years is 460657

(10462303 - 10001646 )

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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	(10001646)	-10001646	-	-
Year 1	3464091	-6537555	3464091	0.8333	2886743
Year 2	3960038	-2577517	7424129	0.6944	2750026
Year 3	3961315	1383798	11385444	0.5787	2292428
Year 4	3237522	4621320	14622966	0.4823	1561305
TOTAL					9490502

The Net NPV after 4 years is -511144

At 20% discount rate the NPV is negative (9490502 - 10001646 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Speedsim Acquisition 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 Speedsim Acquisition has a NPV value higher than Zero then finance managers at Speedsim Acquisition 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 Speedsim Acquisition, then the stock price of the Speedsim Acquisition 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 Speedsim Acquisition 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 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.

What can impact the cash flow of the project.

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 Quickturn's Acquisition of SpeedSim (B): "Doomed from the Start"

References & Further Readings

Naeem Zafar (2018), "Quickturn's Acquisition of SpeedSim (B): "Doomed from the Start" Harvard Business Review Case Study. Published by HBR Publications.