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First Look: The Second Annual New Intelligent Enterprise Survey 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 First Look: The Second Annual New Intelligent Enterprise Survey case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. First Look: The Second Annual New Intelligent Enterprise Survey case study is a Harvard Business School (HBR) case study written by Nina Kruschwitz. The First Look: The Second Annual New Intelligent Enterprise Survey (referred as “Survey Data” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, IT.

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 First Look: The Second Annual New Intelligent Enterprise Survey Case Study


How are companies using analytics in their decision making? To what extent are managers able to access the data they need? What are the key challenges, and how have the main business objectives changed? MIT Sloan Management Review and the IBM Institute for Business Value teamed up to ask business executives, managers and analysts to reflect on the role data plays within their organizations, and received more than 4,000 responses, representing every major industry and every region of the world. Complete results of the second annual survey are scheduled for publication in the fall 2011 issue, but this article provides some preliminary findings. A few early results stand out: Only about four in 10 respondents have access to the information they want; almost one-fifth say they have limited or no access to the data they need to be successful. The three biggest challenges people cite in using analytics are the difficulties of "integrating internal data across silos," the time and cost of performing analytics and the lack of skills to interpret and leverage the data. While the top three business objectives organizations cite for using analytics have not changed since last year's survey, their order of importance has changed: Last year, respondents said the most important objective was "innovating to achieve competitive differentiation;" this year, the No. 1 priority is "growing revenue," followed by "reducing costs and increasing efficiencies." Innovating to achieve competitive differentiation fell to No. 3. All told, the 2011 survey contained 27 questions. The charts in this preview article represent the answers to just eight of those, presented as simple raw data, clean and uncut. In the complete report, the new information will be combined and refined and, in many cases, compared to last year's data to give readers a snapshot of what's changed since our initial survey and the opportunity to benchmark their organizations in relation to their peers. This is an MIT Sloan Management Review article.


Case Authors : Nina Kruschwitz

Topic : Organizational Development

Related Areas : IT




Calculating Net Present Value (NPV) at 6% for First Look: The Second Annual New Intelligent Enterprise Survey Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10018034) -10018034 - -
Year 1 3468751 -6549283 3468751 0.9434 3272407
Year 2 3959163 -2590120 7427914 0.89 3523641
Year 3 3974524 1384404 11402438 0.8396 3337087
Year 4 3236328 4620732 14638766 0.7921 2563475
TOTAL 14638766 12696609




The Net Present Value at 6% discount rate is 2678575

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. Payback Period
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. Timing of the expected cash flows – stockholders of Survey Data 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. Survey Data shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of First Look: The Second Annual New Intelligent Enterprise Survey

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 Survey Data 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 Survey Data 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 (10018034) -10018034 - -
Year 1 3468751 -6549283 3468751 0.8696 3016305
Year 2 3959163 -2590120 7427914 0.7561 2993696
Year 3 3974524 1384404 11402438 0.6575 2613314
Year 4 3236328 4620732 14638766 0.5718 1850381
TOTAL 10473696


The Net NPV after 4 years is 455662

(10473696 - 10018034 )








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 (10018034) -10018034 - -
Year 1 3468751 -6549283 3468751 0.8333 2890626
Year 2 3959163 -2590120 7427914 0.6944 2749419
Year 3 3974524 1384404 11402438 0.5787 2300072
Year 4 3236328 4620732 14638766 0.4823 1560729
TOTAL 9500846


The Net NPV after 4 years is -517188

At 20% discount rate the NPV is negative (9500846 - 10018034 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Survey Data 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 Survey Data has a NPV value higher than Zero then finance managers at Survey Data 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 Survey Data, then the stock price of the Survey Data 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 Survey Data 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.






Negotiation Strategy of First Look: The Second Annual New Intelligent Enterprise Survey

References & Further Readings

Nina Kruschwitz (2018), "First Look: The Second Annual New Intelligent Enterprise Survey Harvard Business Review Case Study. Published by HBR Publications.


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