Airbnb in Amsterdam (B) 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 Airbnb in Amsterdam (B) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Airbnb in Amsterdam (B) case study is a Harvard Business School (HBR) case study written by Mitchell Weiss, Emer Moloney, Vincent Dessain. The Airbnb in Amsterdam (B) (referred as “Airbnb Amsterdam” 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, Innovation, Operations management, Policy.

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 Airbnb in Amsterdam (B) Case Study

In December 2014, the City of Amsterdam and Airbnb announced an MOU to promote responsible home-sharing and to simplify the payment of tourist tax for hosts in the City. It was the most comprehensive agreement that Airbnb had with any city in the world. It's final provision read, "The parties trust that theirs will be a fruitful cooperation." However, both sides were uncertain about how the agreement would be received. Molly Turner, Airbnb's Global Head of Civic Partnership and Tanja de Coster, an Airbnb lawyer in Europe, were unsure how Airbnb's hosts would react. As were their Airbnb colleagues. Laila Frank, who had been an advisor to the Deputy Mayor in Amsterdam, heralded the reputational gains from the agreement for the city, "We were worldwide news. In that way it worked out really well." But she acknowledged that there were also skeptical points of view. "The only immediate result was the tax agreement, which we were really happy about. But the rest had to be proven."

Case Authors : Mitchell Weiss, Emer Moloney, Vincent Dessain

Topic : Innovation & Entrepreneurship

Related Areas : Entrepreneurship, Innovation, Operations management, Policy

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Calculating Net Present Value (NPV) at 6% for Airbnb in Amsterdam (B) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10021805)	-10021805	-	-
Year 1	3447687	-6574118	3447687	0.9434	3252535
Year 2	3974651	-2599467	7422338	0.89	3537425
Year 3	3962640	1363173	11384978	0.8396	3327109
Year 4	3234539	4597712	14619517	0.7921	2562058
TOTAL			14619517		12679127

The Net Present Value at 6% discount rate is 2657322

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Airbnb Amsterdam 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 Airbnb Amsterdam 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 Airbnb in Amsterdam (B)

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 Airbnb Amsterdam 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 Airbnb Amsterdam 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	(10021805)	-10021805	-	-
Year 1	3447687	-6574118	3447687	0.8696	2997989
Year 2	3974651	-2599467	7422338	0.7561	3005407
Year 3	3962640	1363173	11384978	0.6575	2605500
Year 4	3234539	4597712	14619517	0.5718	1849358
TOTAL					10458254

The Net NPV after 4 years is 436449

(10458254 - 10021805 )

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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	(10021805)	-10021805	-	-
Year 1	3447687	-6574118	3447687	0.8333	2873073
Year 2	3974651	-2599467	7422338	0.6944	2760174
Year 3	3962640	1363173	11384978	0.5787	2293194
Year 4	3234539	4597712	14619517	0.4823	1559866
TOTAL					9486308

The Net NPV after 4 years is -535497

At 20% discount rate the NPV is negative (9486308 - 10021805 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Airbnb Amsterdam 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 Airbnb Amsterdam has a NPV value higher than Zero then finance managers at Airbnb Amsterdam 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 Airbnb Amsterdam, then the stock price of the Airbnb Amsterdam 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 Airbnb Amsterdam 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.

Understanding of risks involved in 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.

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 Airbnb in Amsterdam (B)

References & Further Readings

Mitchell Weiss, Emer Moloney, Vincent Dessain (2018), "Airbnb in Amsterdam (B) Harvard Business Review Case Study. Published by HBR Publications.