Started as Crew (C): McDonald's Strategy for Corporate Success and Poverty Reduction 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 Started as Crew (C): McDonald's Strategy for Corporate Success and Poverty Reduction case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Started as Crew (C): McDonald's Strategy for Corporate Success and Poverty Reduction case study is a Harvard Business School (HBR) case study written by Pat Werhane, Regina Wolfe, Laura Pincus Hartman, Justin Sheehan. The Started as Crew (C): McDonald's Strategy for Corporate Success and Poverty Reduction (referred as “Crew Mcdonald's” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Ethics, Human resource management, Leadership, Motivating people.

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 Started as Crew (C): McDonald's Strategy for Corporate Success and Poverty Reduction Case Study

This is a Darden case study.From the early 1970s to the beginning of the 21st century, multinational corporations (MNCs) had increasingly participated in the reduction of poverty as part of their business strategies. Such participation reflected an increasing awareness of the widening gap between rich and poor across the globe. McDonald's Corporation, despite myriad criticisms directed at it about dead-end jobs and the detrimental effects of fast food, had defied norms, however. The company used a combination of promotion-from-within strategy and benchmark employee training programs to develop an abundant pool of human capital. The company was deeply committed to its employees who "started as crew" rising through the ranks, receiving the necessary training at its Hamburger University. This case details the rise of McDonald's, its particular culture, and its emphasis on and pride in the "stared as crew" element, and illustrates these elements with stories of various employees who rose through the ranks to management and executive positions.

Case Authors : Pat Werhane, Regina Wolfe, Laura Pincus Hartman, Justin Sheehan

Topic : Organizational Development

Related Areas : Ethics, Human resource management, Leadership, Motivating people

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Calculating Net Present Value (NPV) at 6% for Started as Crew (C): McDonald's Strategy for Corporate Success and Poverty Reduction Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10017799)	-10017799	-	-
Year 1	3445710	-6572089	3445710	0.9434	3250670
Year 2	3954046	-2618043	7399756	0.89	3519087
Year 3	3953138	1335095	11352894	0.8396	3319131
Year 4	3246071	4581166	14598965	0.7921	2571192
TOTAL			14598965		12660080

The Net Present Value at 6% discount rate is 2642281

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

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. Crew Mcdonald's 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 Crew Mcdonald's 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 Started as Crew (C): McDonald's Strategy for Corporate Success and Poverty Reduction

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 Crew Mcdonald's 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 Crew Mcdonald's 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	(10017799)	-10017799	-	-
Year 1	3445710	-6572089	3445710	0.8696	2996270
Year 2	3954046	-2618043	7399756	0.7561	2989827
Year 3	3953138	1335095	11352894	0.6575	2599252
Year 4	3246071	4581166	14598965	0.5718	1855952
TOTAL					10441300

The Net NPV after 4 years is 423501

(10441300 - 10017799 )

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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	(10017799)	-10017799	-	-
Year 1	3445710	-6572089	3445710	0.8333	2871425
Year 2	3954046	-2618043	7399756	0.6944	2745865
Year 3	3953138	1335095	11352894	0.5787	2287696
Year 4	3246071	4581166	14598965	0.4823	1565428
TOTAL					9470414

The Net NPV after 4 years is -547385

At 20% discount rate the NPV is negative (9470414 - 10017799 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Crew Mcdonald's 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 Crew Mcdonald's has a NPV value higher than Zero then finance managers at Crew Mcdonald's 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 Crew Mcdonald's, then the stock price of the Crew Mcdonald's 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 Crew Mcdonald's 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 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.

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

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 Started as Crew (C): McDonald's Strategy for Corporate Success and Poverty Reduction

References & Further Readings

Pat Werhane, Regina Wolfe, Laura Pincus Hartman, Justin Sheehan (2018), "Started as Crew (C): McDonald's Strategy for Corporate Success and Poverty Reduction Harvard Business Review Case Study. Published by HBR Publications.