Renesas Electronics and the Automotive Microcontroller Supply Chain (A) 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 Renesas Electronics and the Automotive Microcontroller Supply Chain (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Renesas Electronics and the Automotive Microcontroller Supply Chain (A) case study is a Harvard Business School (HBR) case study written by Willy Shih, Margaret Pierson. The Renesas Electronics and the Automotive Microcontroller Supply Chain (A) (referred as “Renesas Differentiation” 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, Risk management, Supply chain.

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 Renesas Electronics and the Automotive Microcontroller Supply Chain (A) Case Study

To maximize their effectiveness, color cases should be printed in color.The magnitude 9.0 earthquake that struck Japan in March, 2011 caused extensive damage to Renesas Electronics wafer fabrication facility, a critical link in the global automotive supply chain. Many OEMs sole-sourced customized microprocessors from the fab so its shutdown forced the "Big Three" of Detroit and Japan to shutdown production as well. Data from two automotive customers in particular, allowing the instructor to look at issues of delayed differentiation, sole-sourcing decisions, and/or Renesas' market position as a producer of low-volume customized components, in the context of supply chain disaster recovery. The two OEM's had different strategies with respect to cross-utilization of components between product lines. Therefore, a simple numerical assignment will show students the power of delayed differentiation in components. The OEM with higher cross-utilization (lower customization of components between product lines) had more flexibility in which vehicles they stopped producing during the shortage. Similarly, students can look at the impact of delayed differentiation at the product level by looking at the production process within the fab itself. Here Renesas's customization causes early differentiation. Again numbers are provided to work examples. Finally, broader questions around the viability of Renesas's market position can be discussed. How should they respond to the disaster in the short term? How can they assure customers they can handle future disruptions differently? And from the OEMs' perspective, do they need to change their product design to allow for the incorporation of alternative parts? Such parts have downsides of their own. The findings in the two numerical examples can be used to drive this discussion, or a general strategy framework may be applied.

Case Authors : Willy Shih, Margaret Pierson

Topic : Leadership & Managing People

Related Areas : Risk management, Supply chain

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Calculating Net Present Value (NPV) at 6% for Renesas Electronics and the Automotive Microcontroller Supply Chain (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012235)	-10012235	-	-
Year 1	3468680	-6543555	3468680	0.9434	3272340
Year 2	3970883	-2572672	7439563	0.89	3534072
Year 3	3947112	1374440	11386675	0.8396	3314071
Year 4	3249668	4624108	14636343	0.7921	2574041
TOTAL			14636343		12694524

The Net Present Value at 6% discount rate is 2682289

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. Internal Rate of Return
2. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Renesas Differentiation 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 Renesas Differentiation 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 Renesas Electronics and the Automotive Microcontroller Supply Chain (A)

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 Renesas Differentiation 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 Renesas Differentiation 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	(10012235)	-10012235	-	-
Year 1	3468680	-6543555	3468680	0.8696	3016243
Year 2	3970883	-2572672	7439563	0.7561	3002558
Year 3	3947112	1374440	11386675	0.6575	2595290
Year 4	3249668	4624108	14636343	0.5718	1858008
TOTAL					10472100

The Net NPV after 4 years is 459865

(10472100 - 10012235 )

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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	(10012235)	-10012235	-	-
Year 1	3468680	-6543555	3468680	0.8333	2890567
Year 2	3970883	-2572672	7439563	0.6944	2757558
Year 3	3947112	1374440	11386675	0.5787	2284208
Year 4	3249668	4624108	14636343	0.4823	1567162
TOTAL					9499495

The Net NPV after 4 years is -512740

At 20% discount rate the NPV is negative (9499495 - 10012235 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Renesas Differentiation 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 Renesas Differentiation has a NPV value higher than Zero then finance managers at Renesas Differentiation 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 Renesas Differentiation, then the stock price of the Renesas Differentiation 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 Renesas Differentiation 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 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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

Understanding of risks involved in the project.

What can impact the cash flow of 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 Renesas Electronics and the Automotive Microcontroller Supply Chain (A)

References & Further Readings

Willy Shih, Margaret Pierson (2018), "Renesas Electronics and the Automotive Microcontroller Supply Chain (A) Harvard Business Review Case Study. Published by HBR Publications.