Singapore Airlines (C): Managing a Strategic Paradox 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 Singapore Airlines (C): Managing a Strategic Paradox case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Singapore Airlines (C): Managing a Strategic Paradox case study is a Harvard Business School (HBR) case study written by Daina Mazutis, John Weeks, Luis Vivanco, Ivy Buche. The Singapore Airlines (C): Managing a Strategic Paradox (referred as “Singapore Airlines” 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, Market research.

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 Singapore Airlines (C): Managing a Strategic Paradox Case Study

Supplement to case IMD724. The C case takes a broader geographical view, while focusing on Singapore Airlines' strategic differentiation. The airline, while being widely considered as the standard bearer in terms of quality and customer service, has been able to achieve some of the lowest cost structures in the industry, surpassing even some LCCs. To meet this seeming paradox while minimizing trade-offs, Singapore Airlines draws the line between things that are valued by the customer, where procedural and cultural ingenuity are promoted, and things that have no effect on the traveler, where cost efficiency is sought. Learning objectives: To investigate how, why and where SIA manages its cost/service trade-offs. To identify the key internal characteristics that allow Singapore Airlines to consistently beat its rivals in terms of customer service and profitability.

Case Authors : Daina Mazutis, John Weeks, Luis Vivanco, Ivy Buche

Topic : Leadership & Managing People

Related Areas : Market research

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Calculating Net Present Value (NPV) at 6% for Singapore Airlines (C): Managing a Strategic Paradox Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10005991)	-10005991	-	-
Year 1	3448523	-6557468	3448523	0.9434	3253324
Year 2	3963767	-2593701	7412290	0.89	3527739
Year 3	3950360	1356659	11362650	0.8396	3316798
Year 4	3241227	4597886	14603877	0.7921	2567355
TOTAL			14603877		12665216

The Net Present Value at 6% discount rate is 2659225

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

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. Singapore Airlines 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 Singapore Airlines 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 Singapore Airlines (C): Managing a Strategic Paradox

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 Singapore Airlines 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 Singapore Airlines 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	(10005991)	-10005991	-	-
Year 1	3448523	-6557468	3448523	0.8696	2998716
Year 2	3963767	-2593701	7412290	0.7561	2997177
Year 3	3950360	1356659	11362650	0.6575	2597426
Year 4	3241227	4597886	14603877	0.5718	1853182
TOTAL					10446501

The Net NPV after 4 years is 440510

(10446501 - 10005991 )

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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	(10005991)	-10005991	-	-
Year 1	3448523	-6557468	3448523	0.8333	2873769
Year 2	3963767	-2593701	7412290	0.6944	2752616
Year 3	3950360	1356659	11362650	0.5787	2286088
Year 4	3241227	4597886	14603877	0.4823	1563092
TOTAL					9475565

The Net NPV after 4 years is -530426

At 20% discount rate the NPV is negative (9475565 - 10005991 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Singapore Airlines 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 Singapore Airlines has a NPV value higher than Zero then finance managers at Singapore Airlines 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 Singapore Airlines, then the stock price of the Singapore Airlines 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 Singapore Airlines 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 can impact the cash flow of 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.

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 Singapore Airlines (C): Managing a Strategic Paradox

References & Further Readings

Daina Mazutis, John Weeks, Luis Vivanco, Ivy Buche (2018), "Singapore Airlines (C): Managing a Strategic Paradox Harvard Business Review Case Study. Published by HBR Publications.