The BareBones NPV tool: When you need to quantify, but really don’t have the information

Trying to figure out what a new initiative might do for you?  A traditional approach is the net present value calculation. This nifty little tool offers an alternative with just 9 input metrics.

The net present value (NPV) rule has become a taken for granted metric for making decisions about where to invest your resources.  The idea is simple:  project cash flows, both positive and negative, into the future, discount them back to today’s values and compare – if positive, invest, if negative, don’t. 

I’m pretty skeptical about using NPV as a rule for guiding investment in new capabilities (and have great company in the form of this article by Clay Christenson and collaborators).  Recognizing this sense of unease, however, doesn’t change that fact that for many managers, an NPV calculation is non-negotiable when it comes to making the case for an important resource commitment.  Therefore, when my co-author and I were working on our book Discovery Driven Growth, we created an Excel-based tool that simulates an NPV calculation.

Over the years, the tool got a little long in the tooth and we ended up taking it down to work on it.  But --- it’s back! In a new and usable format.  

Simulating financial assumptions

Calculating an NPV can be a time-consuming and fiddly exercise. The good news is that if you are hoping to think through an investment in a new venture, you can achieve roughly-right results with a pared down version of NPV.  Instead of laboriously calculating year-by-year spreadsheets over the entire life of a proposed project, you need to estimate only nine project values.

  1. Launch Time.  How long will it be before the project begins to generate its first revenues?

  2. Ramp-Up Time.  How long will it take the project to move from its first revenues to a steady state?  The BareBones NPV estimator will assume that this is a linear ramp-up period.

  3. Competitive Response Time.  How long after launch will it take for competitors to respond?

  4. Competitive Erosion Time.  How long will it take for the competitors to erode your profits to the point that you are only just recovering your fixed costs? The BareBones NPV estimator will assume that profits drop off linearly from the state of the competitive response time to the end of the erosion time.  

  5. Total investment.  What is the expected total investment?  The BareBones NPV estimator will assume that this is a one-time investment incurred at the end of the launch time.

  6. Discount Rate.  This number is used to “discount” future cash flows to account for the fact that if you weren’t doing this project, you could just as easily leave your money in a bank account and earn interest.  The idea is that a sum of money in your pocket today is worth more than the same amount five years from now.  

  7. Expected annual fixed costs

  8. Expected annual variable costs per unit at steady state

  9. Expected annual revenues in units at steady state

For the purposes of this calculator, we assume that the terminal value or salvage value is zero.  If it turns out that there is some value there (as I’ve written about elsewhere) that is awesome, but shouldn’t drive your initial investment decision.  Indeed, in a world of transient advantage, you’re a lot better off assuming that competitive advantage will erode rather than making investments today assuming there will be value left over.  

Dealing with Challengers

The BareBones analysis gives you a simple, rough-but-ready estimate of the NPV of the project for comparison with competing projects.  It also allows you to make your financial assumptions explicit.  Nothing more accurate than a BareBones NPV is really needed for uncertain investments, since you know many – if not most -- of your metrics are wrong before you even start calculating them.  

If someone suggests that the project may take longer to get to steady state, or that competition may enter sooner, or that fixed costs may be higher, or any other of the nit-picky questions you may get at a presentation, you have an easy response.  You can challenge nit-pickers to say what their number is, enter it into the BareBones estimator, and – bang – in seconds, you have the revised NPV.  

Download the calculator

To download the BareBones NPV calculator, visit this page on the Valize web site:

This will take you to a “purchase” page with a zero charge.  Provide your email and address and you’ll receive a link to the downloadable calculator.  Remember to click “Enable Editing” in your Excel document or you won’t be able to change the values.  

How do you use the Outputs?

The BareBones NPV calculator can be used for a number of different purposes.  We like to use it during checkpoint review meetings as a quick and simple way to test the financial assumptions underlying our plans.  You can also use it as part of a disengagement “Zombie project” review to see if the project will ever have the potential to turn positive.  You can use it to compare different kinds of projects.  Mostly, we find it’s a quick way to get at pivotal questions of financial viability for a project without having to sink huge amounts of time into quantifications of fantasy.

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