How Twitter Users Can Generate Better Ideas 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 How Twitter Users Can Generate Better Ideas case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. How Twitter Users Can Generate Better Ideas case study is a Harvard Business School (HBR) case study written by Salvatore Parise, Eoin Whelan, Steve Todd. The How Twitter Users Can Generate Better Ideas (referred as “Twitter Ideas” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Social platforms.

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 How Twitter Users Can Generate Better Ideas Case Study

What prompts people to come up with their best ideas? Even Steve Jobs, renowned for his digital evangelism, recognized the importance of social interaction in achieving innovation. As CEO of Pixar Animation Studios, Jobs explicitly instructed the architect of Pixar's new headquarters to design physical space that encouraged staff to get out of their offices and mingle. Jobs believed that serendipitous exchanges released creative juices that fueled innovation. Empirical studies confirm what Jobs intuitively knew. The more diverse a person's social network, the more likely that person is to be innovative. A diverse network provides exposure to people from different fields who behave and think differently. Can Twitter make employees more innovative? Does having more diversity in one's virtual connections mean that good ideas are more likely to surface, as in the face-to-face world? To answer this question, the authors analyzed employee Twitter networks. EMC Corporation, a leading company in the information storage and infrastructure industry, was one of the five companies the authors studied, analyzing hundreds of ideas submitted by EMC employees. The researchers found that, while Twitter users and non-users generally submitted the same number of ideas, the ideas of Twitter users were rated significantly more positively by other employees and experts than the ideas of non-users. The researchers also found that there was a positive relationship between the amount of diversity in one's Twitter network and the quality of ideas submitted. However, the authors argue that just exposing oneself to diverse fields, opinions and beliefs on Twitter by itself is not sufficient to enhance innovativeness. Additional capabilities are needed to ensure that the ideas triggered via Twitter would be transformed into real innovative outcomes. A critical ability is individual absorptive capacity -the ability of employees to identify, assimilate and exploit new ideas. Two activities closely linked with increasing individual absorptive capacity and personal innovation are "idea scouting,"which entails looking outside the organization for new ideas, and "idea connecting,"which involves finding opportunities within the organization to implement the new concepts. The authors found that Twitter users who performed both roles were the most innovative. This is an MIT Sloan Management Review article.

Case Authors : Salvatore Parise, Eoin Whelan, Steve Todd

Topic : Innovation & Entrepreneurship

Related Areas : Social platforms

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Calculating Net Present Value (NPV) at 6% for How Twitter Users Can Generate Better Ideas Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10006963)	-10006963	-	-
Year 1	3456668	-6550295	3456668	0.9434	3261008
Year 2	3982810	-2567485	7439478	0.89	3544687
Year 3	3973250	1405765	11412728	0.8396	3336017
Year 4	3249594	4655359	14662322	0.7921	2573983
TOTAL			14662322		12715694

The Net Present Value at 6% discount rate is 2708731

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

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 Twitter Ideas 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. Twitter Ideas 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 How Twitter Users Can Generate Better Ideas

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 Twitter Ideas 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 Twitter Ideas 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	(10006963)	-10006963	-	-
Year 1	3456668	-6550295	3456668	0.8696	3005798
Year 2	3982810	-2567485	7439478	0.7561	3011577
Year 3	3973250	1405765	11412728	0.6575	2612476
Year 4	3249594	4655359	14662322	0.5718	1857966
TOTAL					10487817

The Net NPV after 4 years is 480854

(10487817 - 10006963 )

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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	(10006963)	-10006963	-	-
Year 1	3456668	-6550295	3456668	0.8333	2880557
Year 2	3982810	-2567485	7439478	0.6944	2765840
Year 3	3973250	1405765	11412728	0.5787	2299334
Year 4	3249594	4655359	14662322	0.4823	1567127
TOTAL					9512858

The Net NPV after 4 years is -494105

At 20% discount rate the NPV is negative (9512858 - 10006963 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Twitter Ideas 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 Twitter Ideas has a NPV value higher than Zero then finance managers at Twitter Ideas 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 Twitter Ideas, then the stock price of the Twitter Ideas 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 Twitter Ideas 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.

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.

What can impact the cash flow of the project.

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

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 How Twitter Users Can Generate Better Ideas

References & Further Readings

Salvatore Parise, Eoin Whelan, Steve Todd (2018), "How Twitter Users Can Generate Better Ideas Harvard Business Review Case Study. Published by HBR Publications.