Uber: Changing The Way The World Moves 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 Uber: Changing The Way The World Moves case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Uber: Changing The Way The World Moves case study is a Harvard Business School (HBR) case study written by Youngme Moon. The Uber: Changing The Way The World Moves (referred as “Uber Disruptive” 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, Disruptive innovation, Operations management, Pricing, Strategy.

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 Uber: Changing The Way The World Moves Case Study

In 2015, Uber is building what may be the largest point-to-point transportation network of its kind; it is literally changing the way the world moves. But unlike traditional transportation logistics companies like FedEx, Uber has an incredibly lightweight infrastructure: It owns no vehicles, employs no drivers, and pays no vehicle maintenance costs. Instead, its network relies on peer-to-peer coordination between drivers and passengers, enabled by sophisticated software and a clever reputation system. But despite its remarkable early success, Uber is an extremely polarizing company. Its business model is highly disruptive, and while disruptive innovation can be a good thing, it is also true that disruptive companies tend to break things. This is certainly true for Uber, and is one of the key tensions in the case: Uber's innovative business model is outpacing many of the laws regulating its industry, and while it is going to take the regulatory system some time to catch up, Uber doesn't appear to be willing to wait.

Case Authors : Youngme Moon

Topic : Leadership & Managing People

Related Areas : Disruptive innovation, Operations management, Pricing, Strategy

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Calculating Net Present Value (NPV) at 6% for Uber: Changing The Way The World Moves Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016716)	-10016716	-	-
Year 1	3470305	-6546411	3470305	0.9434	3273873
Year 2	3964285	-2582126	7434590	0.89	3528200
Year 3	3957629	1375503	11392219	0.8396	3322902
Year 4	3240602	4616105	14632821	0.7921	2566860
TOTAL			14632821		12691834

The Net Present Value at 6% discount rate is 2675118

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. Payback Period
3. Profitability Index
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. Timing of the expected cash flows – stockholders of Uber Disruptive 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. Uber Disruptive shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Uber: Changing The Way The World Moves

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 Uber Disruptive 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 Uber Disruptive 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	(10016716)	-10016716	-	-
Year 1	3470305	-6546411	3470305	0.8696	3017657
Year 2	3964285	-2582126	7434590	0.7561	2997569
Year 3	3957629	1375503	11392219	0.6575	2602205
Year 4	3240602	4616105	14632821	0.5718	1852825
TOTAL					10470256

The Net NPV after 4 years is 453540

(10470256 - 10016716 )

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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	(10016716)	-10016716	-	-
Year 1	3470305	-6546411	3470305	0.8333	2891921
Year 2	3964285	-2582126	7434590	0.6944	2752976
Year 3	3957629	1375503	11392219	0.5787	2290295
Year 4	3240602	4616105	14632821	0.4823	1562790
TOTAL					9497981

The Net NPV after 4 years is -518735

At 20% discount rate the NPV is negative (9497981 - 10016716 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Uber Disruptive 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 Uber Disruptive has a NPV value higher than Zero then finance managers at Uber Disruptive 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 Uber Disruptive, then the stock price of the Uber Disruptive 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 Uber Disruptive 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 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.

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 Uber: Changing The Way The World Moves

References & Further Readings

Youngme Moon (2018), "Uber: Changing The Way The World Moves Harvard Business Review Case Study. Published by HBR Publications.