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Finding the Right Role for Social Media in Innovation 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 Finding the Right Role for Social Media in Innovation case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Finding the Right Role for Social Media in Innovation case study is a Harvard Business School (HBR) case study written by Deborah L. Roberts, Frank T. Pillar. The Finding the Right Role for Social Media in Innovation (referred as “Media Social” 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, Social platforms.

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 Finding the Right Role for Social Media in Innovation Case Study


Social media success stories have highlighted the impact social media can have on companies'fortunes. Yet the authors argue that there is a significant opportunity that isn't being realized: utilizing social media to support innovation and new product development. Consultants and academics alike have touted social media as a vehicle for developing customer insights, accessing knowledge, cocreating ideas and concepts with users, and supporting new product launches. Yet despite this promise, the authors have found that the expected positive results are frequently not realized in practice. Although some companies have been able to use social media to develop new insights that lead to successful new products, many others simply do not know how to utilize social media for innovation. Some get distracted by the diversity of input and listen to the "wrong audience."Nevertheless, the authors believe that social media provides a game-changing opportunity for companies that learn how to develop clear strategies and objectives. Analyzing data on the social media practices of large global companies as they relate to new product development, the authors found that for the companies that jumped on the bandwagon and invested in social media initiatives without having a clear strategy, the right skills, or sufficient knowledge frequently did not achieve the results they were looking for. Those that utilized social media sources exclusively to search for technical information saw no improvements in new product development performance; in fact, the effect on performance for these companies was often negative (due to information overload and the complexity of processing such information). The companies that benefited the most from using social media for new product development were companies that used social media in every stage of the new product development processes; they built organizational processes and structures to support new product development activity. The authors use the analogy of summer camp, a setting where children can explore and learn from everything they do. They describe three "camps": Camp Explore, Camp Cocreate, and Camp Communicate. Each camp offers a distinctive approach to thinking about the different phases of the innovation process and delivers an important skill set. This is an MIT Sloan Management Review article.


Case Authors : Deborah L. Roberts, Frank T. Pillar

Topic : Leadership & Managing People

Related Areas : Social platforms




Calculating Net Present Value (NPV) at 6% for Finding the Right Role for Social Media in Innovation Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10005413) -10005413 - -
Year 1 3445255 -6560158 3445255 0.9434 3250241
Year 2 3961047 -2599111 7406302 0.89 3525318
Year 3 3960875 1361764 11367177 0.8396 3325627
Year 4 3247101 4608865 14614278 0.7921 2572008
TOTAL 14614278 12673193


The Net Present Value at 6% discount rate is 2667780

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. Internal Rate of Return
3. Profitability Index
4. Payback Period

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 Media Social 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. Media Social 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 Finding the Right Role for Social Media in Innovation

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 Media Social 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 Media Social 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 (10005413) -10005413 - -
Year 1 3445255 -6560158 3445255 0.8696 2995874
Year 2 3961047 -2599111 7406302 0.7561 2995121
Year 3 3960875 1361764 11367177 0.6575 2604340
Year 4 3247101 4608865 14614278 0.5718 1856541
TOTAL 10451875


The Net NPV after 4 years is 446462

(10451875 - 10005413 )






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 (10005413) -10005413 - -
Year 1 3445255 -6560158 3445255 0.8333 2871046
Year 2 3961047 -2599111 7406302 0.6944 2750727
Year 3 3960875 1361764 11367177 0.5787 2292173
Year 4 3247101 4608865 14614278 0.4823 1565924
TOTAL 9479870


The Net NPV after 4 years is -525543

At 20% discount rate the NPV is negative (9479870 - 10005413 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Media Social 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 Media Social has a NPV value higher than Zero then finance managers at Media Social 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 Media Social, then the stock price of the Media Social 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 Media Social 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.




References & Further Readings

Deborah L. Roberts, Frank T. Pillar (2018), "Finding the Right Role for Social Media in Innovation Harvard Business Review Case Study. Published by HBR Publications.