Mastering the Market Intelligence Challenge 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 Mastering the Market Intelligence Challenge case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Mastering the Market Intelligence Challenge case study is a Harvard Business School (HBR) case study written by Murali D.R. Chari, Kimberlee Luce, Inder Thukral. The Mastering the Market Intelligence Challenge (referred as “Intelligence Emerging” 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, 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 Mastering the Market Intelligence Challenge Case Study

This is an MIT Sloan Management Review Article. Multinational companies have invested heavily in emerging economies - over $3 trillion since 1998, by one estimate. Many of these companies, however, have not adapted their products and operations sufficiently to succeed in these markets, and returns have often been mediocre. Even when managers think they are performing well in emerging markets, they often are not because they have set low expectations. Adapting products and operations requires obtaining and using good market intelligence, which is difficult in emerging markets due to the paucity and unreliability of information. Another factor is the wide heterogeneity of emerging markets compared to developed markets. A third common problem is a lack of shared responsibility for market intelligence between headquarters and country managers, so market intelligence that is collected either is dismissed as not credible or is not updated often enough to keep pace with the rate of change in emerging markets. The authors argue that companies can overcome these difficulties by (1) treating market intelligence as a strategic asset; (2) organizing differently for market intelligence in emerging markets; and (3) using a wide range of sources and methods for market intelligence in emerging markets. They also recommend that market intelligence be organized as a shared responsibility between the corporate office and emerging-market business executives, with shared decision rights and shared resources. The article includes examples illustrating how companies such as Wrigley, Unilever, and Procter & Gamble obtain market intelligence in emerging markets.

Case Authors : Murali D.R. Chari, Kimberlee Luce, Inder Thukral

Topic : Leadership & Managing People

Related Areas : Strategy

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Calculating Net Present Value (NPV) at 6% for Mastering the Market Intelligence Challenge Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10015192)	-10015192	-	-
Year 1	3472077	-6543115	3472077	0.9434	3275544
Year 2	3971577	-2571538	7443654	0.89	3534689
Year 3	3939069	1367531	11382723	0.8396	3307318
Year 4	3233516	4601047	14616239	0.7921	2561248
TOTAL			14616239		12678800

The Net Present Value at 6% discount rate is 2663608

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. Profitability Index
3. Net Present Value
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 Intelligence Emerging 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. Intelligence Emerging 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 Mastering the Market Intelligence Challenge

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 Intelligence Emerging 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 Intelligence Emerging 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	(10015192)	-10015192	-	-
Year 1	3472077	-6543115	3472077	0.8696	3019197
Year 2	3971577	-2571538	7443654	0.7561	3003083
Year 3	3939069	1367531	11382723	0.6575	2590002
Year 4	3233516	4601047	14616239	0.5718	1848773
TOTAL					10461055

The Net NPV after 4 years is 445863

(10461055 - 10015192 )

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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	(10015192)	-10015192	-	-
Year 1	3472077	-6543115	3472077	0.8333	2893398
Year 2	3971577	-2571538	7443654	0.6944	2758040
Year 3	3939069	1367531	11382723	0.5787	2279554
Year 4	3233516	4601047	14616239	0.4823	1559373
TOTAL					9490364

The Net NPV after 4 years is -524828

At 20% discount rate the NPV is negative (9490364 - 10015192 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Intelligence Emerging 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 Intelligence Emerging has a NPV value higher than Zero then finance managers at Intelligence Emerging 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 Intelligence Emerging, then the stock price of the Intelligence Emerging 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 Intelligence Emerging 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 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.

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.

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Negotiation Strategy of Mastering the Market Intelligence Challenge

References & Further Readings

Murali D.R. Chari, Kimberlee Luce, Inder Thukral (2018), "Mastering the Market Intelligence Challenge Harvard Business Review Case Study. Published by HBR Publications.