Strategies for Preventing a Knowledge-Loss Crisis 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 Strategies for Preventing a Knowledge-Loss Crisis case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Strategies for Preventing a Knowledge-Loss Crisis case study is a Harvard Business School (HBR) case study written by Salvatore Parise, Rob Cross, Thomas H. Davenport. The Strategies for Preventing a Knowledge-Loss Crisis (referred as “Knowledge Departure” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, .

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 Strategies for Preventing a Knowledge-Loss Crisis Case Study

This is an MIT Sloan Management Review article. When employees leave an organization, they depart with more than what they know; they also leave with critical knowledge about who they know. Thus, the departure of key people can significantly affect the relationship structure and consequent functioning of an organization. In particular, companies should be aware of the unique knowledge held by three important types of employees: "central connectors" (those who are regularly asked for help, typically because they have a high level of expertise in one or more areas), "brokers" (those who act as bridges across subgroups) and "peripheral players" (those who reside on the boundaries of a network but could still possess valuable niche expertise and outside knowledge). Departure of an employee who filled any one of these roles presents knowledge-loss risks that need to be addressed. The departure of a handful of key brokers, for example, could fracture the social network of an organization into isolated subgroups. Thus companies need to take various measures to (1) identify key knowledge vulnerabilities by virtue of both what a person knows and how that individual's departure will affect a network and (2) address specific knowledge-loss issues based on the different roles that employees play in the network.

Case Authors : Salvatore Parise, Rob Cross, Thomas H. Davenport

Topic : Organizational Development

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Strategies for Preventing a Knowledge-Loss Crisis Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10027095)	-10027095	-	-
Year 1	3459669	-6567426	3459669	0.9434	3263839
Year 2	3963765	-2603661	7423434	0.89	3527737
Year 3	3953040	1349379	11376474	0.8396	3319049
Year 4	3248972	4598351	14625446	0.7921	2573490
TOTAL			14625446		12684114

The Net Present Value at 6% discount rate is 2657019

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. Internal Rate of Return
3. Net Present Value
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. Knowledge Departure 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 Knowledge Departure 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 Strategies for Preventing a Knowledge-Loss Crisis

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 Knowledge Departure 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 Knowledge Departure 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	(10027095)	-10027095	-	-
Year 1	3459669	-6567426	3459669	0.8696	3008408
Year 2	3963765	-2603661	7423434	0.7561	2997176
Year 3	3953040	1349379	11376474	0.6575	2599188
Year 4	3248972	4598351	14625446	0.5718	1857610
TOTAL					10462382

The Net NPV after 4 years is 435287

(10462382 - 10027095 )

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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	(10027095)	-10027095	-	-
Year 1	3459669	-6567426	3459669	0.8333	2883058
Year 2	3963765	-2603661	7423434	0.6944	2752615
Year 3	3953040	1349379	11376474	0.5787	2287639
Year 4	3248972	4598351	14625446	0.4823	1566827
TOTAL					9490138

The Net NPV after 4 years is -536957

At 20% discount rate the NPV is negative (9490138 - 10027095 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Knowledge Departure 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 Knowledge Departure has a NPV value higher than Zero then finance managers at Knowledge Departure 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 Knowledge Departure, then the stock price of the Knowledge Departure 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 Knowledge Departure 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 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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 Strategies for Preventing a Knowledge-Loss Crisis

References & Further Readings

Salvatore Parise, Rob Cross, Thomas H. Davenport (2018), "Strategies for Preventing a Knowledge-Loss Crisis Harvard Business Review Case Study. Published by HBR Publications.