×




Microsoft: New Wine in an Old Bottle? 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 Microsoft: New Wine in an Old Bottle? case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Microsoft: New Wine in an Old Bottle? case study is a Harvard Business School (HBR) case study written by Ali Farhoomand, W.H. Lo. The Microsoft: New Wine in an Old Bottle? (referred as “Microsoft Mobile” 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, Change management, Collaboration, Corporate governance, Growth strategy, Leadership, Organizational structure, Strategic planning, Supply chain.

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 Microsoft: New Wine in an Old Bottle? Case Study


Within four weeks of becoming the new CEO of Microsoft, Satya Nadella lays out the major challenges that await him in the two letters he sends to everyone at Microsoft. He defines Microsoft's battlefield as the "mobile-first and cloud-first world". That is where Microsoft needs to get its products and technology right, to build platforms and ecosystems and to integrate Nokia devices, services and the new mobile capabilities. In order to do so, Microsoft needs to zero in on "a mobile and cloud-first world and do new things." In his view "...industry does not respect tradition - it only respects innovation". And in order to innovate, he needs his 125,000 strong staff around the world to lead and help drive cultural change, to find Microsoft's swing so that the team is "...in such perfect unison that no single action by any one is out of synch with those of all the others". Many challenges await Microsoft in its transformation journey. On platforms, it is not clear what the future will hold for Windows. On devices, Microsoft needs to find ways to woo application developers to build its mobile ecosystem. On integration, the Company has to find ways to transfer and to grow the mobile capability acquired from Nokia. And most importantly, Nadella must figure out how he can achieve cultural changes to focus everyone on innovation via collaboration.


Case Authors : Ali Farhoomand, W.H. Lo

Topic : Leadership & Managing People

Related Areas : Change management, Collaboration, Corporate governance, Growth strategy, Leadership, Organizational structure, Strategic planning, Supply chain




Calculating Net Present Value (NPV) at 6% for Microsoft: New Wine in an Old Bottle? Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10002899) -10002899 - -
Year 1 3463522 -6539377 3463522 0.9434 3267474
Year 2 3957631 -2581746 7421153 0.89 3522278
Year 3 3944464 1362718 11365617 0.8396 3311848
Year 4 3243719 4606437 14609336 0.7921 2569329
TOTAL 14609336 12670928




The Net Present Value at 6% discount rate is 2668029

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. Payback Period
2. Profitability Index
3. Internal Rate of Return
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 Microsoft Mobile 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. Microsoft Mobile 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 Microsoft: New Wine in an Old Bottle?

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 Microsoft Mobile 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 Microsoft Mobile 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 (10002899) -10002899 - -
Year 1 3463522 -6539377 3463522 0.8696 3011758
Year 2 3957631 -2581746 7421153 0.7561 2992538
Year 3 3944464 1362718 11365617 0.6575 2593549
Year 4 3243719 4606437 14609336 0.5718 1854607
TOTAL 10452452


The Net NPV after 4 years is 449553

(10452452 - 10002899 )








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 (10002899) -10002899 - -
Year 1 3463522 -6539377 3463522 0.8333 2886268
Year 2 3957631 -2581746 7421153 0.6944 2748355
Year 3 3944464 1362718 11365617 0.5787 2282676
Year 4 3243719 4606437 14609336 0.4823 1564293
TOTAL 9481593


The Net NPV after 4 years is -521306

At 20% discount rate the NPV is negative (9481593 - 10002899 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Microsoft Mobile 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 Microsoft Mobile has a NPV value higher than Zero then finance managers at Microsoft Mobile 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 Microsoft Mobile, then the stock price of the Microsoft Mobile 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 Microsoft Mobile 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 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.

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.

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.






Negotiation Strategy of Microsoft: New Wine in an Old Bottle?

References & Further Readings

Ali Farhoomand, W.H. Lo (2018), "Microsoft: New Wine in an Old Bottle? Harvard Business Review Case Study. Published by HBR Publications.


Hong Wei Asia SWOT Analysis / TOWS Matrix

Capital Goods , Constr. - Supplies & Fixtures


SDM SWOT Analysis / TOWS Matrix

Services , Recreational Activities


Beijing Bohui Innovation SWOT Analysis / TOWS Matrix

Healthcare , Medical Equipment & Supplies


Chrometco SWOT Analysis / TOWS Matrix

Capital Goods , Construction - Raw Materials


Nepon SWOT Analysis / TOWS Matrix

Capital Goods , Constr. - Supplies & Fixtures


ODK Solutions SWOT Analysis / TOWS Matrix

Technology , Computer Services


M J Gleeson Group SWOT Analysis / TOWS Matrix

Capital Goods , Construction Services