Tracy Chan: "We Need to Talk" 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 Tracy Chan: "We Need to Talk" case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Tracy Chan: "We Need to Talk" case study is a Harvard Business School (HBR) case study written by Paul Bigus, Jana Seijts. The Tracy Chan: "We Need to Talk" (referred as “Hinske Chan” 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, .

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 Tracy Chan: "We Need to Talk" Case Study

Tracy Chan, managing director of the Student Learning and Writing Services (SLWS) at St. Charles University in Calgary Alberta was faced with a difficult situation. Her newest employee Michael Hinske, had just emailed her a list of faculty members he had contacted to educate on the SLWS graduate writing initiatives. Chan quickly noticed that the faculty names were contacts that had already been initiated. There was no indication that Hinske had made any attempt to discuss the program with other faculties on campus. Since joining the team six months earlier Hinske's mandate for the academic year was to create a series of workshops and liaison with different faculties on campus. Due to restructuring the funding request for the position originally made by Chan was resubmitted under Nicole Duncan, the associate director of the Faculty Educational Development Office (FEDO). The result was the approval of a position that would see the SLSW receive a staff member four days per week and one day per week in the FEDO. Duncan wanted to have a direct role in the recruiting since she was to be responsible for the overseeing of the budget for the initiative. She called Chan to inform her that a resume from Michael Hinske had been sent directly to her and that it should be included in the pile if potential candidates. After the interview process Duncan stated that the best candidate for the position was Hinske. Chan stated her hesitation with the candidate given that he lacked any formal training in writing theory and the disciplines of writing at the university level. However, Duncan stated that she wanted the job filled before she went on vacation and Hinske should be given the job. Problems started when Hinske asked for other team member's presentations and curriculum material. Over the next two months Chan and other staff members noticed that Hinske seemed distant.

Case Authors : Paul Bigus, Jana Seijts

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Tracy Chan: "We Need to Talk" Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10025962)	-10025962	-	-
Year 1	3457454	-6568508	3457454	0.9434	3261749
Year 2	3959642	-2608866	7417096	0.89	3524067
Year 3	3942184	1333318	11359280	0.8396	3309934
Year 4	3233075	4566393	14592355	0.7921	2560898
TOTAL			14592355		12656648

The Net Present Value at 6% discount rate is 2630686

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. Payback Period
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. Hinske Chan 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 Hinske Chan 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 Tracy Chan: "We Need to Talk"

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 Hinske Chan 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 Hinske Chan 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	(10025962)	-10025962	-	-
Year 1	3457454	-6568508	3457454	0.8696	3006482
Year 2	3959642	-2608866	7417096	0.7561	2994058
Year 3	3942184	1333318	11359280	0.6575	2592050
Year 4	3233075	4566393	14592355	0.5718	1848521
TOTAL					10441111

The Net NPV after 4 years is 415149

(10441111 - 10025962 )

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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	(10025962)	-10025962	-	-
Year 1	3457454	-6568508	3457454	0.8333	2881212
Year 2	3959642	-2608866	7417096	0.6944	2749751
Year 3	3942184	1333318	11359280	0.5787	2281356
Year 4	3233075	4566393	14592355	0.4823	1559160
TOTAL					9471480

The Net NPV after 4 years is -554482

At 20% discount rate the NPV is negative (9471480 - 10025962 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Hinske Chan 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 Hinske Chan has a NPV value higher than Zero then finance managers at Hinske Chan 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 Hinske Chan, then the stock price of the Hinske Chan 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 Hinske Chan 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 –

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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.

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 Tracy Chan: "We Need to Talk"

References & Further Readings

Paul Bigus, Jana Seijts (2018), "Tracy Chan: "We Need to Talk" Harvard Business Review Case Study. Published by HBR Publications.