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The Change Leadership Sustainability Demands 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 The Change Leadership Sustainability Demands case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Change Leadership Sustainability Demands case study is a Harvard Business School (HBR) case study written by Daniel Goleman, Christoph Lueneburger. The The Change Leadership Sustainability Demands (referred as “Sustainability Phase” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Sustainability.

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 The Change Leadership Sustainability Demands Case Study


This is an MIT Sloan Management Review article. Many companies are well aware of the need to make their businesses more sustainable but stumble badly in making that transition. Often they mistakenly assume that the sustainability initiative will require a single, sustained effort over years when, in fact, it will entail three distinct phases, each needing different leadership skills on the part of the executive heading the effort. In phase 1, the sustainability leader must be able to communicate a compelling vision and gain buy-in from key opinion formers in the organization. In addition, the leader must help identify, define and develop a specific set of business processes that are geared to manage previously unquantified risks and capture new opportunities. When a company emerges from phase 1, commercial orientation becomes the key competence. Now the task is to translate high-level commitments into a comprehensive change program with clearly defined initiatives and hard commercial targets. To make this happen, sustainability leaders in phase 2 must excel at delivering results, and they must have a strong commercial awareness. At the end of this phase, sustainability becomes an organization-wide imperative that is tracked through economic, environmental and social metrics over the business planning cycle. In phase 3, the need for commercial orientation continues unabated but is matched by a strong strategic orientation. The sustainability leader must be adept at anticipating and evaluating long-term sustainability trends, spotting new opportunities and developing strategies to reposition the organization to benefit from them. The goal is to have sustainability become embedded in the organization's DNA, such that it is a core value and the organization is unconsciously proactive about it.


Case Authors : Daniel Goleman, Christoph Lueneburger

Topic : Organizational Development

Related Areas : Sustainability




Calculating Net Present Value (NPV) at 6% for The Change Leadership Sustainability Demands Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10026808) -10026808 - -
Year 1 3462563 -6564245 3462563 0.9434 3266569
Year 2 3962677 -2601568 7425240 0.89 3526768
Year 3 3968363 1366795 11393603 0.8396 3331914
Year 4 3227697 4594492 14621300 0.7921 2556638
TOTAL 14621300 12681890




The Net Present Value at 6% discount rate is 2655082

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. 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. Timing of the expected cash flows – stockholders of Sustainability Phase 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. Sustainability Phase 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 The Change Leadership Sustainability Demands

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 Sustainability Phase 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 Sustainability Phase 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 (10026808) -10026808 - -
Year 1 3462563 -6564245 3462563 0.8696 3010924
Year 2 3962677 -2601568 7425240 0.7561 2996353
Year 3 3968363 1366795 11393603 0.6575 2609263
Year 4 3227697 4594492 14621300 0.5718 1845446
TOTAL 10461987


The Net NPV after 4 years is 435179

(10461987 - 10026808 )








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 (10026808) -10026808 - -
Year 1 3462563 -6564245 3462563 0.8333 2885469
Year 2 3962677 -2601568 7425240 0.6944 2751859
Year 3 3968363 1366795 11393603 0.5787 2296506
Year 4 3227697 4594492 14621300 0.4823 1556567
TOTAL 9490401


The Net NPV after 4 years is -536407

At 20% discount rate the NPV is negative (9490401 - 10026808 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Sustainability Phase 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 Sustainability Phase has a NPV value higher than Zero then finance managers at Sustainability Phase 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 Sustainability Phase, then the stock price of the Sustainability Phase 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 Sustainability Phase 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 will be a multi year spillover effect of various taxation regulations.

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 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 The Change Leadership Sustainability Demands

References & Further Readings

Daniel Goleman, Christoph Lueneburger (2018), "The Change Leadership Sustainability Demands Harvard Business Review Case Study. Published by HBR Publications.


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