Advanced Leadership Note: An Institutional Perspective and Framework for Managing and Leading 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 Advanced Leadership Note: An Institutional Perspective and Framework for Managing and Leading case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Advanced Leadership Note: An Institutional Perspective and Framework for Managing and Leading case study is a Harvard Business School (HBR) case study written by Rosabeth Moss Kanter, Rakesh Khurana. The Advanced Leadership Note: An Institutional Perspective and Framework for Managing and Leading (referred as “Solutions Societal” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Leadership, Social enterprise.

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 Advanced Leadership Note: An Institutional Perspective and Framework for Managing and Leading Case Study

Large-scale societal issues increasingly appear on the agenda of business leaders, including poverty, health, education, business-government relations, and the degradation of the environment. These problems are not entirely new, but the forces of globalization and the economic crisis have made them more visible and increase their urgency. They share several characteristics that signal the need for new kinds of societal leadership and academic scholarship. From the perspective of leadership, one common characteristic of these global problems is that they include both technical and political components. The political context surrounding any problem must be understood and managed, and a variety of institutions across sectors must be mobilized before technical solutions can be applied. Along similar lines, technical knowledge of solutions alone is not enough to scale successful demonstration projects that address these complex problems. That step involves resources and skills centered on forging appropriate systemic connections to effectively distribute solutions. Thus, these challenges cannot be dealt with by one profession or institution acting alone; indeed, effective action most often occurs at the intersections of professional and institutional fields. Holistic solutions, however, can be difficult to implement because of the complex interactions (or failures to interact) among many participants who deal with just one piece of an issue. Finally, solutions to these problems require concurrent actions at several system levels and/or among many stakeholders. This means that social capital as well as financial capital is required to forge relationships, influence opinion leaders and gatekeepers, and ensure cultural appropriateness.

Case Authors : Rosabeth Moss Kanter, Rakesh Khurana

Topic : Organizational Development

Related Areas : Leadership, Social enterprise

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Calculating Net Present Value (NPV) at 6% for Advanced Leadership Note: An Institutional Perspective and Framework for Managing and Leading Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016567)	-10016567	-	-
Year 1	3464537	-6552030	3464537	0.9434	3268431
Year 2	3959673	-2592357	7424210	0.89	3524095
Year 3	3936681	1344324	11360891	0.8396	3305313
Year 4	3235396	4579720	14596287	0.7921	2562737
TOTAL			14596287		12660576

The Net Present Value at 6% discount rate is 2644009

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. Internal Rate of Return
3. Profitability Index
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 Solutions Societal 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. Solutions Societal 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 Advanced Leadership Note: An Institutional Perspective and Framework for Managing and Leading

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 Solutions Societal 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 Solutions Societal 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	(10016567)	-10016567	-	-
Year 1	3464537	-6552030	3464537	0.8696	3012641
Year 2	3959673	-2592357	7424210	0.7561	2994082
Year 3	3936681	1344324	11360891	0.6575	2588432
Year 4	3235396	4579720	14596287	0.5718	1849848
TOTAL					10445002

The Net NPV after 4 years is 428435

(10445002 - 10016567 )

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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	(10016567)	-10016567	-	-
Year 1	3464537	-6552030	3464537	0.8333	2887114
Year 2	3959673	-2592357	7424210	0.6944	2749773
Year 3	3936681	1344324	11360891	0.5787	2278172
Year 4	3235396	4579720	14596287	0.4823	1560280
TOTAL					9475339

The Net NPV after 4 years is -541228

At 20% discount rate the NPV is negative (9475339 - 10016567 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Solutions Societal 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 Solutions Societal has a NPV value higher than Zero then finance managers at Solutions Societal 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 Solutions Societal, then the stock price of the Solutions Societal 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 Solutions Societal 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 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.

Understanding of risks involved in the project.

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.

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 Advanced Leadership Note: An Institutional Perspective and Framework for Managing and Leading

References & Further Readings

Rosabeth Moss Kanter, Rakesh Khurana (2018), "Advanced Leadership Note: An Institutional Perspective and Framework for Managing and Leading Harvard Business Review Case Study. Published by HBR Publications.