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Hubtown (A): Designing a Bottom-Up Approach to Performance Management 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 Hubtown (A): Designing a Bottom-Up Approach to Performance Management case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Hubtown (A): Designing a Bottom-Up Approach to Performance Management case study is a Harvard Business School (HBR) case study written by Kajari Mukherjee, Meenakshi Aggarwal-Gupta. The Hubtown (A): Designing a Bottom-Up Approach to Performance Management (referred as “Hubtown Implement” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Developing employees.

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 Hubtown (A): Designing a Bottom-Up Approach to Performance Management Case Study


In 2014, Hubtown Limited (Hubtown), an Indian real estate development company, was attempting to implement a process to differentiate between its employees in order to enhance performance, identify employees who could be groomed for future growth, and distribute rewards. Hubtown was consolidating to concentrate on a few large, complex projects in residential and commercial spaces in urban centres. Like other companies in the industry, it competed for talent and faced challenges when attempting to retain, reward, and promote valuable employees. Earlier efforts to implement a results-based performance management system had failed, so the organization decided to design and adopt a behaviour-based approach and to implement it from the bottom up to bypass resistance from senior management. Case A describes the challenges the human resources head faced in creating an institutionalized performance culture and designing the implementation plan for this system. Case B describes the implementation process and presents the initiatives taken by the human resources team to implement the process, train the stakeholders, and address challenges along the way. Kajari Mukherjee and Meenakshi Aggarwal-Gupta are affiliated with Indian Institute of Management Indore.


Case Authors : Kajari Mukherjee, Meenakshi Aggarwal-Gupta

Topic : Organizational Development

Related Areas : Developing employees




Calculating Net Present Value (NPV) at 6% for Hubtown (A): Designing a Bottom-Up Approach to Performance Management Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10007154) -10007154 - -
Year 1 3472613 -6534541 3472613 0.9434 3276050
Year 2 3978485 -2556056 7451098 0.89 3540837
Year 3 3961462 1405406 11412560 0.8396 3326120
Year 4 3238908 4644314 14651468 0.7921 2565519
TOTAL 14651468 12708526




The Net Present Value at 6% discount rate is 2701372

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. Internal Rate of Return
2. Profitability Index
3. Payback Period
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Hubtown Implement 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 Hubtown Implement 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 Hubtown (A): Designing a Bottom-Up Approach to Performance Management

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 Hubtown Implement 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 Hubtown Implement 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 (10007154) -10007154 - -
Year 1 3472613 -6534541 3472613 0.8696 3019663
Year 2 3978485 -2556056 7451098 0.7561 3008306
Year 3 3961462 1405406 11412560 0.6575 2604726
Year 4 3238908 4644314 14651468 0.5718 1851856
TOTAL 10484551


The Net NPV after 4 years is 477397

(10484551 - 10007154 )








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 (10007154) -10007154 - -
Year 1 3472613 -6534541 3472613 0.8333 2893844
Year 2 3978485 -2556056 7451098 0.6944 2762837
Year 3 3961462 1405406 11412560 0.5787 2292513
Year 4 3238908 4644314 14651468 0.4823 1561973
TOTAL 9511167


The Net NPV after 4 years is -495987

At 20% discount rate the NPV is negative (9511167 - 10007154 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Hubtown Implement 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 Hubtown Implement has a NPV value higher than Zero then finance managers at Hubtown Implement 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 Hubtown Implement, then the stock price of the Hubtown Implement 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 Hubtown Implement 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 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 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.

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 Hubtown (A): Designing a Bottom-Up Approach to Performance Management

References & Further Readings

Kajari Mukherjee, Meenakshi Aggarwal-Gupta (2018), "Hubtown (A): Designing a Bottom-Up Approach to Performance Management Harvard Business Review Case Study. Published by HBR Publications.


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