Public Architecture 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 Public Architecture case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Public Architecture case study is a Harvard Business School (HBR) case study written by Lakshmi Ramarajan, Christopher Marquis, Bobbi Thomason. The Public Architecture (referred as “Architecture Design” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Design, Growth strategy, Organizational culture, Organizational structure, Social enterprise, Social responsibility.

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 Public Architecture Case Study

To maximize their effectiveness, color cases should be printed in color.Public Architecture is a non-profit architecture company dedicated to creating social and professional change through design for the public good. Public has focused on three strategies to create change: 1) promoting the design community's commitment to pro bono work, 2) inspiring action through creating design with a social mission, and 3) disseminating knowledge created by socially relevant design throughout the profession. As a central actor and change agent in the profession, Public Architecture created The 1% Program, a national network of architecture and design firms that have publicly pledged to donate 1% of their billable hours to the public good. However, the organization has been struggling to keep both The 1% Program and its own design initiatives integrated and reinforcing each other in creating social and professional change. Should Public split into two organizations? Would keeping the diverse elements within Public Architecture together force the entire organization to the least common denominator or would it provide them with a flexible platform for creating social change? These questions have important implications for Public's growth strategy, their funding, and resource allocation decisions.

Case Authors : Lakshmi Ramarajan, Christopher Marquis, Bobbi Thomason

Topic : Organizational Development

Related Areas : Design, Growth strategy, Organizational culture, Organizational structure, Social enterprise, Social responsibility

---

Calculating Net Present Value (NPV) at 6% for Public Architecture Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10002680)	-10002680	-	-
Year 1	3460476	-6542204	3460476	0.9434	3264600
Year 2	3968581	-2573623	7429057	0.89	3532023
Year 3	3943797	1370174	11372854	0.8396	3311288
Year 4	3222756	4592930	14595610	0.7921	2552725
TOTAL			14595610		12660636

The Net Present Value at 6% discount rate is 2657956

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

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. Architecture Design 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 Architecture Design have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

---

Formula and Steps to Calculate Net Present Value (NPV) of Public Architecture

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 Organizational Development 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 Architecture Design 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 Architecture Design 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	(10002680)	-10002680	-	-
Year 1	3460476	-6542204	3460476	0.8696	3009110
Year 2	3968581	-2573623	7429057	0.7561	3000817
Year 3	3943797	1370174	11372854	0.6575	2593111
Year 4	3222756	4592930	14595610	0.5718	1842621
TOTAL					10445659

The Net NPV after 4 years is 442979

(10445659 - 10002680 )

---

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	(10002680)	-10002680	-	-
Year 1	3460476	-6542204	3460476	0.8333	2883730
Year 2	3968581	-2573623	7429057	0.6944	2755959
Year 3	3943797	1370174	11372854	0.5787	2282290
Year 4	3222756	4592930	14595610	0.4823	1554184
TOTAL					9476163

The Net NPV after 4 years is -526517

At 20% discount rate the NPV is negative (9476163 - 10002680 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Architecture Design 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 Architecture Design has a NPV value higher than Zero then finance managers at Architecture Design 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 Architecture Design, then the stock price of the Architecture Design 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 Architecture Design 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 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.

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.

---

Negotiation Strategy of Public Architecture

References & Further Readings

Lakshmi Ramarajan, Christopher Marquis, Bobbi Thomason (2018), "Public Architecture Harvard Business Review Case Study. Published by HBR Publications.