Rewriting the Playbook for Corporate Partnerships 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 Rewriting the Playbook for Corporate Partnerships case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Rewriting the Playbook for Corporate Partnerships case study is a Harvard Business School (HBR) case study written by F de AsA?s MartA?nez-Jerez. The Rewriting the Playbook for Corporate Partnerships (referred as “Bharti Vendors” 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, Operations 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

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Case Description of Rewriting the Playbook for Corporate Partnerships Case Study

This is an MIT Sloan Management Review article. Today's business environment is unforgiving of companies that are slow to adapt. To extend their capabilities and facilitate change, many organizations have experimented with different types of strategic partnerships with suppliers and customers that help them design and deliver products and services efficiently. But some innovative companies are attempting to redefine the parameters of strategic partnerships through multileveled relationships with customers and suppliers that leverage the resources and capabilities of the respective parties.What makes such partnerships -which the author calls adaptive strategic partnerships -counterintuitive is that they are being used in situations where the two most relevant streams of organizational economics would argue for vertical integration. One company that has pursued adaptive strategic partnerships is Bharti Airtel Ltd., the Indian telecommunications services company. Back in 2004, Bharti Airtel's managers found that negotiating and updating contracts with vendors interfered with their ability to focus on satisfying the company's customers and outsmarting its competition. Contrary to what other telecom operators have done, it negotiated unconventional relationships with some of its leading vendors, including Nokia Siemens Networks (now Nokia Solutions and Networks), Ericsson and IBM. Instead of expanding network infrastructure by purchasing increasing amounts of equipment (such as exchanges and cellular antennas), which often results in unused capacity, Bharti Airtel pays the vendors to operate the network; it compensates them based on telecom volume, paying only when equipment is in use. In addition to rethinking its approach to network capacity, vendors take responsibility for network performance and troubleshooting. Typically, companies with outside partners rely on simple tools such as service-level agreements, which specify what is expected from each party and provide for performance standards to assess compliance. But in managing its partnerships with vendors, Bharti Airtel uses a joint governing structure that encourages people at different levels of the organizations to communicate and address problems as they arise. In some cases, such interactions have led the company and its partners to redraw the scope of their collaborations (for example, assign responsibility for building and maintaining the cell towers to a new company), something that would be more difficult to do in a more traditional partnership. The incentive system rewards vendors for efficient network management. By sharing information with its telecom equipment providers, Bharti Airtel and its partners are incentivized to develop processes that advance learning, innovation and mutual trust. Other companies are shifting the institutional framework on three dimensions: 1) incentives 2) information and 3) collaboration mechanisms. By managing across these dimensions, they are paving the way for the new level of collaboration.

Case Authors : F de AsA?s MartA?nez-Jerez

Topic : Leadership & Managing People

Related Areas : Operations management

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Calculating Net Present Value (NPV) at 6% for Rewriting the Playbook for Corporate Partnerships Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012418)	-10012418	-	-
Year 1	3445681	-6566737	3445681	0.9434	3250642
Year 2	3956937	-2609800	7402618	0.89	3521660
Year 3	3946393	1336593	11349011	0.8396	3313468
Year 4	3228132	4564725	14577143	0.7921	2556983
TOTAL			14577143		12642753

The Net Present Value at 6% discount rate is 2630335

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Bharti Vendors 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 Bharti Vendors have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Rewriting the Playbook for Corporate Partnerships

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 Bharti Vendors 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 Bharti Vendors 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	(10012418)	-10012418	-	-
Year 1	3445681	-6566737	3445681	0.8696	2996244
Year 2	3956937	-2609800	7402618	0.7561	2992013
Year 3	3946393	1336593	11349011	0.6575	2594817
Year 4	3228132	4564725	14577143	0.5718	1845695
TOTAL					10428770

The Net NPV after 4 years is 416352

(10428770 - 10012418 )

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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	(10012418)	-10012418	-	-
Year 1	3445681	-6566737	3445681	0.8333	2871401
Year 2	3956937	-2609800	7402618	0.6944	2747873
Year 3	3946393	1336593	11349011	0.5787	2283792
Year 4	3228132	4564725	14577143	0.4823	1556777
TOTAL					9459843

The Net NPV after 4 years is -552575

At 20% discount rate the NPV is negative (9459843 - 10012418 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Bharti Vendors 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 Bharti Vendors has a NPV value higher than Zero then finance managers at Bharti Vendors 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 Bharti Vendors, then the stock price of the Bharti Vendors 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 Bharti Vendors 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.

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Negotiation Strategy of Rewriting the Playbook for Corporate Partnerships

References & Further Readings

F de AsA?s MartA?nez-Jerez (2018), "Rewriting the Playbook for Corporate Partnerships Harvard Business Review Case Study. Published by HBR Publications.