GenapSys: Business Models for the Genome 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 GenapSys: Business Models for the Genome case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. GenapSys: Business Models for the Genome case study is a Harvard Business School (HBR) case study written by Richard G. Hamermesh, Joseph Fuller, Matthew Preble. The GenapSys: Business Models for the Genome (referred as “Genapsys Sequencers” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Entrepreneurship, Health, Technology.

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 GenapSys: Business Models for the Genome Case Study

GenapSys, a California-based startup, was soon to release a new DNA sequencer that the company's founder, Hesaam Esfandyarpour, believed was truly revolutionary. The sequencer would be substantially less expensive-potentially costing just a few thousand dollars-and smaller than other sequencers, many of which were large devices costing tens of thousands or hundreds of thousands of dollars. GenapSys' device, named GENIUS, could also quickly generate large amounts of data, as it was capable of sequencing an entire human genome in less than eight hours. At this price, GenapSys' device would be attractive to customers that had been unable to afford sequencers, such as smaller laboratories or hospitals, and even expand the market to include industries such as agriculture and biofuels. As GenapSys came closer to releasing its product, Esfandyarpour and his Senior Director of Operations and Strategy, Leila Rastegar (HBS '11), sat down to decide which of three business models they would choose to bring this device to market. In the first model, the company would sell sequencers at a higher price to those entities which already purchased sequencers, primarily major research labs and pharmaceutical firms, but position its machine as a faster alternative to existing technologies. In the second model, GenapSys would sell its sequencer at a lower price but charge more for the cartridges necessary to run a sample, and earn its primary revenue from these cartridges. The third model would see GenapSys sell its device at or around cost, but use the data customers generated to create a proprietary database of genetic information. Customers could pay to access the database for research, to create genetic tests, or for many other purposes. GenapSys would also build an online store with the genetic tests customers created. Esfandyarpour's and Rastegar's decision would determine GenapSys' customer base and financial position for the coming years, and also impact develop Esfandyarpour's and Rastegar's decision would determine GenapSys' customer base and financial position for the coming years, and also impact development and capital needs of the firm. Which was the right model to bring the device to market and have a meaningful impact?

Case Authors : Richard G. Hamermesh, Joseph Fuller, Matthew Preble

Topic : Innovation & Entrepreneurship

Related Areas : Entrepreneurship, Health, Technology

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Calculating Net Present Value (NPV) at 6% for GenapSys: Business Models for the Genome Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10006652)	-10006652	-	-
Year 1	3451711	-6554941	3451711	0.9434	3256331
Year 2	3980353	-2574588	7432064	0.89	3542500
Year 3	3954905	1380317	11386969	0.8396	3320615
Year 4	3224883	4605200	14611852	0.7921	2554409
TOTAL			14611852		12673855

The Net Present Value at 6% discount rate is 2667203

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

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. Genapsys Sequencers 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 Genapsys Sequencers 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 GenapSys: Business Models for the Genome

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 Genapsys Sequencers 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 Genapsys Sequencers 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	(10006652)	-10006652	-	-
Year 1	3451711	-6554941	3451711	0.8696	3001488
Year 2	3980353	-2574588	7432064	0.7561	3009719
Year 3	3954905	1380317	11386969	0.6575	2600414
Year 4	3224883	4605200	14611852	0.5718	1843837
TOTAL					10455458

The Net NPV after 4 years is 448806

(10455458 - 10006652 )

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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	(10006652)	-10006652	-	-
Year 1	3451711	-6554941	3451711	0.8333	2876426
Year 2	3980353	-2574588	7432064	0.6944	2764134
Year 3	3954905	1380317	11386969	0.5787	2288718
Year 4	3224883	4605200	14611852	0.4823	1555210
TOTAL					9484488

The Net NPV after 4 years is -522164

At 20% discount rate the NPV is negative (9484488 - 10006652 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Genapsys Sequencers 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 Genapsys Sequencers has a NPV value higher than Zero then finance managers at Genapsys Sequencers 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 Genapsys Sequencers, then the stock price of the Genapsys Sequencers 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 Genapsys Sequencers 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 can impact the cash flow of 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.

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 GenapSys: Business Models for the Genome

References & Further Readings

Richard G. Hamermesh, Joseph Fuller, Matthew Preble (2018), "GenapSys: Business Models for the Genome Harvard Business Review Case Study. Published by HBR Publications.