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AMD Dresden: Copy Inexactly! 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 AMD Dresden: Copy Inexactly! case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. AMD Dresden: Copy Inexactly! case study is a Harvard Business School (HBR) case study written by Willy Shih. The AMD Dresden: Copy Inexactly! (referred as “Dresden Amd's” 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, Cross-cultural management, Growth strategy, Organizational culture, Strategic planning.

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




Case Description of AMD Dresden: Copy Inexactly! Case Study


To maximize their effectiveness, color cases should be printed in color.The establishment and growth of AMD's Dresden, Germany manufacturing site illustrates how processes develop in an organization, and how those processes get institutionalized into a unique culture. Located in the Free State of Saxony in the eastern part of Germany (the former GDR), AMD's investment in the region leverages a historic and rather unique skill base in engineering and the sciences, and catalyzes the rebirth and growth of one of the largest semiconductor clusters in Europe. Contrary to conventional wisdom in the semiconductor industry, the Dresden team only copied from its home corporate locations in the United States those processes and practices that it felt would work in Germany rather than follow a copy exactly strategy. Dresden becomes AMD's sole worldwide manufacturing location for microprocessors, but now the company is faced with the question of whether it can successfully transplant the highly successful culture to other global locations because of favorable investment incentives.


Case Authors : Willy Shih

Topic : Leadership & Managing People

Related Areas : Cross-cultural management, Growth strategy, Organizational culture, Strategic planning




Calculating Net Present Value (NPV) at 6% for AMD Dresden: Copy Inexactly! Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10019859) -10019859 - -
Year 1 3459705 -6560154 3459705 0.9434 3263873
Year 2 3967748 -2592406 7427453 0.89 3531282
Year 3 3971277 1378871 11398730 0.8396 3334361
Year 4 3230457 4609328 14629187 0.7921 2558825
TOTAL 14629187 12688340


The Net Present Value at 6% discount rate is 2668481

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.




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. Profitability Index
3. Payback Period
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. Dresden Amd's 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 Dresden Amd's have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.




Formula and Steps to Calculate Net Present Value (NPV) of AMD Dresden: Copy Inexactly!

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 Dresden Amd's 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 Dresden Amd's 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 (10019859) -10019859 - -
Year 1 3459705 -6560154 3459705 0.8696 3008439
Year 2 3967748 -2592406 7427453 0.7561 3000188
Year 3 3971277 1378871 11398730 0.6575 2611179
Year 4 3230457 4609328 14629187 0.5718 1847024
TOTAL 10466830


The Net NPV after 4 years is 446971

(10466830 - 10019859 )






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 (10019859) -10019859 - -
Year 1 3459705 -6560154 3459705 0.8333 2883088
Year 2 3967748 -2592406 7427453 0.6944 2755381
Year 3 3971277 1378871 11398730 0.5787 2298193
Year 4 3230457 4609328 14629187 0.4823 1557898
TOTAL 9494559


The Net NPV after 4 years is -525300

At 20% discount rate the NPV is negative (9494559 - 10019859 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Dresden Amd's 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 Dresden Amd's has a NPV value higher than Zero then finance managers at Dresden Amd's 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 Dresden Amd's, then the stock price of the Dresden Amd's 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 Dresden Amd's 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 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 can impact the cash flow of 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.




References & Further Readings

Willy Shih (2018), "AMD Dresden: Copy Inexactly! Harvard Business Review Case Study. Published by HBR Publications.