Building Strong Partnerships at the Inter-American Development Bank 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 Building Strong Partnerships at the Inter-American Development Bank case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Building Strong Partnerships at the Inter-American Development Bank case study is a Harvard Business School (HBR) case study written by Amy C. Edmondson, Erin Henry, Andreas Georgoulias, Natalie Bartlett. The Building Strong Partnerships at the Inter-American Development Bank (referred as “Partnerships Orp” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Economy, Government, Growth strategy, Health, International business, Joint ventures, Leading teams, Organizational culture, Organizational structure, Public relations, Reorganization, Technology.

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 Building Strong Partnerships at the Inter-American Development Bank Case Study

Building Strong Partnerships at the Inter-American Development Bank details the development of the bank's new Office of Outreach Partnerships to sustain a culture of innovation through maintaining and generating partnerships in order to fulfill the bank's greater mission of providing multilateral development financing as well as non-financial technical support and expertise for the Latin American and Caribbean region. At the time the case takes place, the Latin American and Caribbean region had seen changes such as expansion of the middle class, emergence of a new business class, and integration with foreign trade. Additionally, the region had faced challenges such as poverty, education, productivity, and infrastructure in both small and medium enterprises. Finally, new actors had entered the region such as governments, corporations, foundations, academic institutions, and NGO's to take a supporting role. In response, the Inter-American Development Bank (IDB) had created the Office of Outreach and Partnerships (ORP) as a dedicated team to lead strategic collaboration and interactions with a long-term vision for partnerships and innovation. The case portrays key questions concerning how the partnership process was formalized through the development of ORP, and what innovations these new partnerships would bring to the bank. Three example partnerships are detailed including The Coca-Cola Company, The Salud Mesoamerica 2015 Initiative, and PepsiCo. The case concludes by positing questions the ORP would face moving forward such as incentives, metrics, restructuring to serve the private sector, and mechanisms for working with a new set of partners.

Case Authors : Amy C. Edmondson, Erin Henry, Andreas Georgoulias, Natalie Bartlett

Topic : Organizational Development

Related Areas : Economy, Government, Growth strategy, Health, International business, Joint ventures, Leading teams, Organizational culture, Organizational structure, Public relations, Reorganization, Technology

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Calculating Net Present Value (NPV) at 6% for Building Strong Partnerships at the Inter-American Development Bank Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10013595)	-10013595	-	-
Year 1	3447116	-6566479	3447116	0.9434	3251996
Year 2	3959516	-2606963	7406632	0.89	3523955
Year 3	3971247	1364284	11377879	0.8396	3334336
Year 4	3232360	4596644	14610239	0.7921	2560332
TOTAL			14610239		12670619

The Net Present Value at 6% discount rate is 2657024

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. Payback Period
2. Profitability Index
3. Internal Rate of Return
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. Timing of the expected cash flows – stockholders of Partnerships Orp have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Partnerships Orp shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Building Strong Partnerships at the Inter-American Development Bank

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 Partnerships Orp 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 Partnerships Orp 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	(10013595)	-10013595	-	-
Year 1	3447116	-6566479	3447116	0.8696	2997492
Year 2	3959516	-2606963	7406632	0.7561	2993963
Year 3	3971247	1364284	11377879	0.6575	2611159
Year 4	3232360	4596644	14610239	0.5718	1848112
TOTAL					10450727

The Net NPV after 4 years is 437132

(10450727 - 10013595 )

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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	(10013595)	-10013595	-	-
Year 1	3447116	-6566479	3447116	0.8333	2872597
Year 2	3959516	-2606963	7406632	0.6944	2749664
Year 3	3971247	1364284	11377879	0.5787	2298175
Year 4	3232360	4596644	14610239	0.4823	1558816
TOTAL					9479251

The Net NPV after 4 years is -534344

At 20% discount rate the NPV is negative (9479251 - 10013595 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Partnerships Orp 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 Partnerships Orp has a NPV value higher than Zero then finance managers at Partnerships Orp 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 Partnerships Orp, then the stock price of the Partnerships Orp 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 Partnerships Orp 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 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.

What can impact the cash flow of 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.

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Negotiation Strategy of Building Strong Partnerships at the Inter-American Development Bank

References & Further Readings

Amy C. Edmondson, Erin Henry, Andreas Georgoulias, Natalie Bartlett (2018), "Building Strong Partnerships at the Inter-American Development Bank Harvard Business Review Case Study. Published by HBR Publications.