Big Data, Analytics and the Path From Insights to Value 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 Big Data, Analytics and the Path From Insights to Value case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Big Data, Analytics and the Path From Insights to Value case study is a Harvard Business School (HBR) case study written by Steve LaValle, Eric Lesser, Rebecca Shockley, Michael S. Hopkins. The Big Data, Analytics and the Path From Insights to Value (referred as “Analytics Survey” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Innovation, 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 Big Data, Analytics and the Path From Insights to Value Case Study

This is an MIT Sloan Management Review article. To understand the challenges and opportunities associated with the use of business analytics, MIT Sloan Management Review, in collaboration with the IBM Institute for Business Value, conducted a survey of more than 3,000 business executives, managers and analysts from organizations located around the world. The survey was part of the 2010 New Intelligent Enterprise Global Executive Study and Research Project, which attempts to understand better how all organizations are trying to capitalize on information and apply analytics today and in the future. One of the most significant findings is that there is a clear connection between performance and the competitive value of analytics. Survey respondents who agreed that the use of business information and analytics differentiated them were twice as likely to be top performers. Three stages, or capability levels, of analytics adoption emerged from the research: aspirational, experienced and transformed. The article provides a comprehensive description of each, enabling organizations to identify where they fall in the continuum. In addition, the authors include suggestions for the best entry points and techniques for each level, and measures to avoid the most common pitfalls. Based on insights from the survey, case studies and interviews with experts, the authors also describe an emerging five-point methodology for successfully implementing analytics-driven management and rapidly creating value -as leading businesses are already managing to do. These include (1) focus on the biggest and highest data priorities, (2) within each of those priorities, start by asking questions, not by looking at the available data, (3) embed insights into business processes to make them more understandable and actionable, (4) keep existing capabilities and tools while adding new ones and (5) develop an overarching information agenda that enables decision making and strategy for the future.

Case Authors : Steve LaValle, Eric Lesser, Rebecca Shockley, Michael S. Hopkins

Topic : Innovation & Entrepreneurship

Related Areas : Innovation, Technology

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Calculating Net Present Value (NPV) at 6% for Big Data, Analytics and the Path From Insights to Value Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10025294)	-10025294	-	-
Year 1	3448400	-6576894	3448400	0.9434	3253208
Year 2	3966441	-2610453	7414841	0.89	3530118
Year 3	3971179	1360726	11386020	0.8396	3334278
Year 4	3233295	4594021	14619315	0.7921	2561072
TOTAL			14619315		12678677

The Net Present Value at 6% discount rate is 2653383

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. Internal Rate of Return
3. Payback Period
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. Timing of the expected cash flows – stockholders of Analytics Survey 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. Analytics Survey 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 Big Data, Analytics and the Path From Insights to Value

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 Analytics Survey 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 Analytics Survey 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	(10025294)	-10025294	-	-
Year 1	3448400	-6576894	3448400	0.8696	2998609
Year 2	3966441	-2610453	7414841	0.7561	2999199
Year 3	3971179	1360726	11386020	0.6575	2611115
Year 4	3233295	4594021	14619315	0.5718	1848647
TOTAL					10457570

The Net NPV after 4 years is 432276

(10457570 - 10025294 )

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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	(10025294)	-10025294	-	-
Year 1	3448400	-6576894	3448400	0.8333	2873667
Year 2	3966441	-2610453	7414841	0.6944	2754473
Year 3	3971179	1360726	11386020	0.5787	2298136
Year 4	3233295	4594021	14619315	0.4823	1559266
TOTAL					9485542

The Net NPV after 4 years is -539752

At 20% discount rate the NPV is negative (9485542 - 10025294 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Analytics Survey 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 Analytics Survey has a NPV value higher than Zero then finance managers at Analytics Survey 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 Analytics Survey, then the stock price of the Analytics Survey 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 Analytics Survey 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 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.

Understanding of risks involved in 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 Big Data, Analytics and the Path From Insights to Value

References & Further Readings

Steve LaValle, Eric Lesser, Rebecca Shockley, Michael S. Hopkins (2018), "Big Data, Analytics and the Path From Insights to Value Harvard Business Review Case Study. Published by HBR Publications.