Capitalism's Next Frontier: Competing in Outer Space (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 Capitalism's Next Frontier: Competing in Outer Space (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Capitalism's Next Frontier: Competing in Outer Space (A) case study is a Harvard Business School (HBR) case study written by Jean-Philippe Vergne, Ken Mark. The Capitalism's Next Frontier: Competing in Outer Space (A) (referred as “Space Outer” 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.

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 Capitalism's Next Frontier: Competing in Outer Space (A) Case Study

Several private startups, including Planetary Resources, SpaceX, and Deep Space Industries, had initiated plans to mine minerals in space. The ventures looked promising: an asteroid one kilometre in diameter contained, potentially, $20 trillion worth of industrial and precious metals. Governments had become involved in space exploration as well, with interests that ranged from projecting military power in space to claiming resources. The current legal framework surrounding space exploration was vague, but the United Nations Treaties and Principles on Outer Space recognized extraterrestrial resources as the "common heritage of humankind." What should a privately funded venture company consider when developing a strategy for space exploration and mining? What would be the concerns of a senior government official or a representative from a global organization such as the United Nations? Are the concerns different for different countries?

Case Authors : Jean-Philippe Vergne, Ken Mark

Topic : Leadership & Managing People

Related Areas : Risk management

---

Calculating Net Present Value (NPV) at 6% for Capitalism's Next Frontier: Competing in Outer Space (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10022939)	-10022939	-	-
Year 1	3461061	-6561878	3461061	0.9434	3265152
Year 2	3977694	-2584184	7438755	0.89	3540133
Year 3	3957466	1373282	11396221	0.8396	3322765
Year 4	3232211	4605493	14628432	0.7921	2560214
TOTAL			14628432		12688264

The Net Present Value at 6% discount rate is 2665325

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. Net Present Value
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. Timing of the expected cash flows – stockholders of Space Outer have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Space Outer shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

---

Formula and Steps to Calculate Net Present Value (NPV) of Capitalism's Next Frontier: Competing in Outer Space (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 Space Outer 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 Space Outer 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	(10022939)	-10022939	-	-
Year 1	3461061	-6561878	3461061	0.8696	3009618
Year 2	3977694	-2584184	7438755	0.7561	3007708
Year 3	3957466	1373282	11396221	0.6575	2602098
Year 4	3232211	4605493	14628432	0.5718	1848027
TOTAL					10467452

The Net NPV after 4 years is 444513

(10467452 - 10022939 )

---

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	(10022939)	-10022939	-	-
Year 1	3461061	-6561878	3461061	0.8333	2884218
Year 2	3977694	-2584184	7438755	0.6944	2762288
Year 3	3957466	1373282	11396221	0.5787	2290200
Year 4	3232211	4605493	14628432	0.4823	1558744
TOTAL					9495449

The Net NPV after 4 years is -527490

At 20% discount rate the NPV is negative (9495449 - 10022939 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Space Outer 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 Space Outer has a NPV value higher than Zero then finance managers at Space Outer 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 Space Outer, then the stock price of the Space Outer 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 Space Outer 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 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 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 Capitalism's Next Frontier: Competing in Outer Space (A)

References & Further Readings

Jean-Philippe Vergne, Ken Mark (2018), "Capitalism's Next Frontier: Competing in Outer Space (A) Harvard Business Review Case Study. Published by HBR Publications.