Adequacy Versus Equivalency: Financial Data Protection and the U.S.-EU Divide 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 Adequacy Versus Equivalency: Financial Data Protection and the U.S.-EU Divide case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Adequacy Versus Equivalency: Financial Data Protection and the U.S.-EU Divide case study is a Harvard Business School (HBR) case study written by Michelle Frasher. The Adequacy Versus Equivalency: Financial Data Protection and the U.S.-EU Divide (referred as “European Union” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Regulation, Security & privacy.

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 Adequacy Versus Equivalency: Financial Data Protection and the U.S.-EU Divide Case Study

In 1995, the European Union passed Directive 95/46/EC, which set the legal framework for European Union citizens to own the rights to their personal data. However, American law bestows ownership to the holder of the data, not the individual, and officials feared the European Union initiative might disrupt data sharing among United States and European Union affiliates. Thus, they negotiated the 2000 Safe Harbor Agreement to allow companies to voluntarily submit to yearly certifications that fulfilled European Union demands, but kept U.S. businesses in control of their data; nevertheless, the Agreement does not include financial and banking services. Instead, the United States argued that the privacy protections within the Gramm-Leach-Bliley Act adequately fulfilled European Union guidelines. The European Union disagreed and financial data sharing has operated under a moratorium for the past decade. However, the 2008 financial crisis has governments and clients clamouring for more data transparency to determine risk in the financial system. These global efforts, the European Union's recent push to strengthen the Directive, and the Dodd-Frank Act have pushed data sharing to the policy forefront. This article asserts that transatlantic data sharing will ultimately have to accommodate the privacy cultures in both the United States and the European Union, but firms must be prepared to cope with demands on their data by establishing government relations offices, standardizing information systems, enhancing education for compliance officers, and improving business school curricula.

Case Authors : Michelle Frasher

Topic : Leadership & Managing People

Related Areas : Regulation, Security & privacy

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Calculating Net Present Value (NPV) at 6% for Adequacy Versus Equivalency: Financial Data Protection and the U.S.-EU Divide Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10000755)	-10000755	-	-
Year 1	3462670	-6538085	3462670	0.9434	3266670
Year 2	3976044	-2562041	7438714	0.89	3538665
Year 3	3963176	1401135	11401890	0.8396	3327559
Year 4	3235591	4636726	14637481	0.7921	2562891
TOTAL			14637481		12695785

The Net Present Value at 6% discount rate is 2695030

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. European Union 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 European Union 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 Adequacy Versus Equivalency: Financial Data Protection and the U.S.-EU Divide

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 Leadership & Managing People 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 European Union 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 European Union 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	(10000755)	-10000755	-	-
Year 1	3462670	-6538085	3462670	0.8696	3011017
Year 2	3976044	-2562041	7438714	0.7561	3006460
Year 3	3963176	1401135	11401890	0.6575	2605853
Year 4	3235591	4636726	14637481	0.5718	1849960
TOTAL					10473290

The Net NPV after 4 years is 472535

(10473290 - 10000755 )

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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	(10000755)	-10000755	-	-
Year 1	3462670	-6538085	3462670	0.8333	2885558
Year 2	3976044	-2562041	7438714	0.6944	2761142
Year 3	3963176	1401135	11401890	0.5787	2293505
Year 4	3235591	4636726	14637481	0.4823	1560374
TOTAL					9500578

The Net NPV after 4 years is -500177

At 20% discount rate the NPV is negative (9500578 - 10000755 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of European Union 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 European Union has a NPV value higher than Zero then finance managers at European Union 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 European Union, then the stock price of the European Union 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 European Union 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 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 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 Adequacy Versus Equivalency: Financial Data Protection and the U.S.-EU Divide

References & Further Readings

Michelle Frasher (2018), "Adequacy Versus Equivalency: Financial Data Protection and the U.S.-EU Divide Harvard Business Review Case Study. Published by HBR Publications.