Right Clients, Right Way: Successes and Challenges of Brand Consultant Tommy Li 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 Right Clients, Right Way: Successes and Challenges of Brand Consultant Tommy Li case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Right Clients, Right Way: Successes and Challenges of Brand Consultant Tommy Li case study is a Harvard Business School (HBR) case study written by Kevin Au, Bernard Suen, Na Shen, Justine Tang. The Right Clients, Right Way: Successes and Challenges of Brand Consultant Tommy Li (referred as “Li Li's” 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, International business.

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 Right Clients, Right Way: Successes and Challenges of Brand Consultant Tommy Li Case Study

Tommy Li was a designer and brand consultant renowned for his black humour and bold visual impact. With business spanning Hong Kong, China, Macau, Japan and Italy, he was one of the few Hong Kong designers to have entered the international market. In his ten years of experience as a design staff member, Li learned that "getting the right client is the key to a successful design consultancy business." Therefore, Li set up his own company to have full freedom in choosing his own clients, and his "choosing clients strategically" philosophy brought him great success. Consequently, he became a famous Hong Kong designer and brand consultant with reputable local and overseas clients. With international firms many times bigger than Li's firm entering China, Li saw mounting competitive pressure. Was Li's stardom an adequate defence against firms composed of multidisciplinary teams equipped with innovation-driven design thinking and processes? Was scale a critical issue in staying competitive? Was proximity to the market an important advantage?The brand consulting industry also faced intense competition from international business consultancies, advertising and public relations agencies. Each camp used a different approach to target the same group of brand-conscious clients. Could Li cope with these challenges?The case was developed to teach designers and design entrepreneurs. It is also suitable for MBA and other executive classes on entrepreneurship and creative business. This case is intended to achieve the following objectives: 1) study how strategic thinking guided Li to develop his design business despite changing market conditions 2) understand how path dependence and dynamic capabilities explain Li's success and challenges in a changing business environment 3) discuss the best approach to grow a design business - building methodology and processes or becoming a star in new markets.

Case Authors : Kevin Au, Bernard Suen, Na Shen, Justine Tang

Topic : Innovation & Entrepreneurship

Related Areas : Entrepreneurship, International business

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Calculating Net Present Value (NPV) at 6% for Right Clients, Right Way: Successes and Challenges of Brand Consultant Tommy Li Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10001539)	-10001539	-	-
Year 1	3446861	-6554678	3446861	0.9434	3251756
Year 2	3956171	-2598507	7403032	0.89	3520978
Year 3	3964780	1366273	11367812	0.8396	3328906
Year 4	3233064	4599337	14600876	0.7921	2560890
TOTAL			14600876		12662529

The Net Present Value at 6% discount rate is 2660990

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. Payback Period
2. Internal Rate of Return
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. Li Li's 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 Li Li's 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 Right Clients, Right Way: Successes and Challenges of Brand Consultant Tommy Li

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 Li Li's 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 Li Li's 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	(10001539)	-10001539	-	-
Year 1	3446861	-6554678	3446861	0.8696	2997270
Year 2	3956171	-2598507	7403032	0.7561	2991434
Year 3	3964780	1366273	11367812	0.6575	2606907
Year 4	3233064	4599337	14600876	0.5718	1848515
TOTAL					10444126

The Net NPV after 4 years is 442587

(10444126 - 10001539 )

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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	(10001539)	-10001539	-	-
Year 1	3446861	-6554678	3446861	0.8333	2872384
Year 2	3956171	-2598507	7403032	0.6944	2747341
Year 3	3964780	1366273	11367812	0.5787	2294433
Year 4	3233064	4599337	14600876	0.4823	1559155
TOTAL					9473313

The Net NPV after 4 years is -528226

At 20% discount rate the NPV is negative (9473313 - 10001539 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Li Li's 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 Li Li's has a NPV value higher than Zero then finance managers at Li Li's 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 Li Li's, then the stock price of the Li Li's 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 Li Li's 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 can impact the cash flow of the project.

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

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.

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 Right Clients, Right Way: Successes and Challenges of Brand Consultant Tommy Li

References & Further Readings

Kevin Au, Bernard Suen, Na Shen, Justine Tang (2018), "Right Clients, Right Way: Successes and Challenges of Brand Consultant Tommy Li Harvard Business Review Case Study. Published by HBR Publications.