Airbnb 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 case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Airbnb case study is a Harvard Business School (HBR) case study written by Andrew Rachleff, Sara Rosenthal. The Airbnb (referred as “Attendees Airbnb” 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, .

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 Case Study

Abstract (Maximum of 2,000 Characters): Briefly describes content of case. The Airbnb case describes the very early days of this startup, beginning with the founders' original concept of renting out air beds and serving breakfast ("Airbed and Breakfast") in their apartment to conference attendees as an alternative to expensive hotel rooms. The founders grew the business by providing finding lodging options in people's homes for attendees of large events such as South by Southwest and the Democratic National Convention. Despite positive reviews and high spikes in activity associated with these events, the founders faced challenges achieving sustainable growth. In early 2009, they joined Y-Combinator and were forced to confront a series of decisions around how to improve the product such that it could grow into a profitable, long-term business.

Case Authors : Andrew Rachleff, Sara Rosenthal

Topic : Leadership & Managing People

Related Areas :

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

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10027340)	-10027340	-	-
Year 1	3470661	-6556679	3470661	0.9434	3274208
Year 2	3963291	-2593388	7433952	0.89	3527315
Year 3	3954296	1360908	11388248	0.8396	3320103
Year 4	3251458	4612366	14639706	0.7921	2575459
TOTAL			14639706		12697086

The Net Present Value at 6% discount rate is 2669746

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. Net Present Value
2. Payback Period
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Attendees Airbnb 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 Attendees Airbnb 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

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 Attendees Airbnb 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 Attendees Airbnb 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	(10027340)	-10027340	-	-
Year 1	3470661	-6556679	3470661	0.8696	3017966
Year 2	3963291	-2593388	7433952	0.7561	2996817
Year 3	3954296	1360908	11388248	0.6575	2600014
Year 4	3251458	4612366	14639706	0.5718	1859032
TOTAL					10473829

The Net NPV after 4 years is 446489

(10473829 - 10027340 )

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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	(10027340)	-10027340	-	-
Year 1	3470661	-6556679	3470661	0.8333	2892218
Year 2	3963291	-2593388	7433952	0.6944	2752285
Year 3	3954296	1360908	11388248	0.5787	2288366
Year 4	3251458	4612366	14639706	0.4823	1568026
TOTAL					9500894

The Net NPV after 4 years is -526446

At 20% discount rate the NPV is negative (9500894 - 10027340 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Attendees Airbnb 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 Attendees Airbnb has a NPV value higher than Zero then finance managers at Attendees Airbnb 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 Attendees Airbnb, then the stock price of the Attendees Airbnb 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 Attendees Airbnb 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 –

Understanding of risks involved in the project.

What can impact the cash flow of 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

References & Further Readings

Andrew Rachleff, Sara Rosenthal (2018), "Airbnb Harvard Business Review Case Study. Published by HBR Publications.