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Live from the Met: Opera in the 21st Century (B) 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 Live from the Met: Opera in the 21st Century (B) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Live from the Met: Opera in the 21st Century (B) case study is a Harvard Business School (HBR) case study written by Sebastien Boutonnet, Serge Poisson-de-Haro. The Live from the Met: Opera in the 21st Century (B) (referred as “Met's Gelb” 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, Technology.

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 Live from the Met: Opera in the 21st Century (B) Case Study


This two-part case looks at the issues related to the Metropolitan Opera's decision to start transmitting its productions in high definition (HD) to movie theatres after the arrival of its new general manager, Peter Gelb, on August 1, 2006. Part A provides students with all the details needed to assess this decision. It outlines the Met's general and competitive position within the performing arts at the time Gelb took over management, explains the Met's business environment (Political, Economic, Social, and Technological (PEST) analysis, its direct and indirect competition in New York and from other major opera houses in the U.S. and around the world), and the facts needed to analyse the various distribution methods available to the Met. It allows students to determine the viability of Gelb's plan to take the Met into movie houses, considering its implications for the company and the changes it would require to the Met's traditional business model as well as its competitive environment. Part B introduces students to the factors underlying the Live in HD project implemented by Gelb and its commercial and financial success. It concludes with a discussion of the possible next steps in the wake of this technological innovation, given that some challenges remain (such as lowering the average age of Met audiences) and their implications from a competitive perspective.


Case Authors : Sebastien Boutonnet, Serge Poisson-de-Haro

Topic : Leadership & Managing People

Related Areas : Technology




Calculating Net Present Value (NPV) at 6% for Live from the Met: Opera in the 21st Century (B) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10003281) -10003281 - -
Year 1 3452731 -6550550 3452731 0.9434 3257293
Year 2 3978033 -2572517 7430764 0.89 3540435
Year 3 3950607 1378090 11381371 0.8396 3317006
Year 4 3250390 4628480 14631761 0.7921 2574613
TOTAL 14631761 12689348




The Net Present Value at 6% discount rate is 2686067

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. 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. Met's Gelb 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 Met's Gelb 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 Live from the Met: Opera in the 21st Century (B)

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 Met's Gelb 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 Met's Gelb 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 (10003281) -10003281 - -
Year 1 3452731 -6550550 3452731 0.8696 3002375
Year 2 3978033 -2572517 7430764 0.7561 3007964
Year 3 3950607 1378090 11381371 0.6575 2597588
Year 4 3250390 4628480 14631761 0.5718 1858421
TOTAL 10466349


The Net NPV after 4 years is 463068

(10466349 - 10003281 )








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 (10003281) -10003281 - -
Year 1 3452731 -6550550 3452731 0.8333 2877276
Year 2 3978033 -2572517 7430764 0.6944 2762523
Year 3 3950607 1378090 11381371 0.5787 2286231
Year 4 3250390 4628480 14631761 0.4823 1567511
TOTAL 9493540


The Net NPV after 4 years is -509741

At 20% discount rate the NPV is negative (9493540 - 10003281 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Met's Gelb 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 Met's Gelb has a NPV value higher than Zero then finance managers at Met's Gelb 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 Met's Gelb, then the stock price of the Met's Gelb 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 Met's Gelb 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 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.

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

Understanding of risks involved in the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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.






Negotiation Strategy of Live from the Met: Opera in the 21st Century (B)

References & Further Readings

Sebastien Boutonnet, Serge Poisson-de-Haro (2018), "Live from the Met: Opera in the 21st Century (B) Harvard Business Review Case Study. Published by HBR Publications.


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