Samsung Electronics: Managing Innovations in an Economic Downturn 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 Samsung Electronics: Managing Innovations in an Economic Downturn case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Samsung Electronics: Managing Innovations in an Economic Downturn case study is a Harvard Business School (HBR) case study written by Ali Farhoomand, Elsha Yiu. The Samsung Electronics: Managing Innovations in an Economic Downturn (referred as “Samsung Electronics” 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, Performance measurement, 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 Samsung Electronics: Managing Innovations in an Economic Downturn Case Study

Samsung Electronics' ambition to go beyond a household brand to become a premium life-style brand through its range of smartphones offers insights into the concept of dynamic capabilities, which drives the management team to stay on course to achieve predictable results. The case illustrates the growth trajectory of a company which has reached a point where growth sustainability becomes a question at the heart of its strategic management.

Case Authors : Ali Farhoomand, Elsha Yiu

Topic : Leadership & Managing People

Related Areas : Performance measurement, Strategy

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Calculating Net Present Value (NPV) at 6% for Samsung Electronics: Managing Innovations in an Economic Downturn Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10020680)	-10020680	-	-
Year 1	3468302	-6552378	3468302	0.9434	3271983
Year 2	3958141	-2594237	7426443	0.89	3522731
Year 3	3942392	1348155	11368835	0.8396	3310108
Year 4	3232176	4580331	14601011	0.7921	2560186
TOTAL			14601011		12665009

The Net Present Value at 6% discount rate is 2644329

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. Payback Period
2. Internal Rate of Return
3. Net Present Value
4. Profitability Index

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. Samsung Electronics 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 Samsung Electronics 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 Samsung Electronics: Managing Innovations in an Economic Downturn

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 Samsung Electronics 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 Samsung Electronics 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	(10020680)	-10020680	-	-
Year 1	3468302	-6552378	3468302	0.8696	3015915
Year 2	3958141	-2594237	7426443	0.7561	2992923
Year 3	3942392	1348155	11368835	0.6575	2592187
Year 4	3232176	4580331	14601011	0.5718	1848007
TOTAL					10449032

The Net NPV after 4 years is 428352

(10449032 - 10020680 )

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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	(10020680)	-10020680	-	-
Year 1	3468302	-6552378	3468302	0.8333	2890252
Year 2	3958141	-2594237	7426443	0.6944	2748709
Year 3	3942392	1348155	11368835	0.5787	2281477
Year 4	3232176	4580331	14601011	0.4823	1558727
TOTAL					9479164

The Net NPV after 4 years is -541516

At 20% discount rate the NPV is negative (9479164 - 10020680 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Samsung Electronics 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 Samsung Electronics has a NPV value higher than Zero then finance managers at Samsung Electronics 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 Samsung Electronics, then the stock price of the Samsung Electronics 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 Samsung Electronics 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 Samsung Electronics: Managing Innovations in an Economic Downturn

References & Further Readings

Ali Farhoomand, Elsha Yiu (2018), "Samsung Electronics: Managing Innovations in an Economic Downturn Harvard Business Review Case Study. Published by HBR Publications.