×




Luca de Meo Speaks at Harvard Business School 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 Luca de Meo Speaks at Harvard Business School case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Luca de Meo Speaks at Harvard Business School case study is a Harvard Business School (HBR) case study written by Linda A. Hill. The Luca de Meo Speaks at Harvard Business School (referred as “Meo Luca” 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, Marketing, Organizational culture.

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 Luca de Meo Speaks at Harvard Business School Case Study


A video supplement to the HBS case study entitled "Luca de Meo at Volkswagen Group." De Meo, Member of the Board at Audi AG and the former Chief Marketing Officer of Volkswagen Group, speaks about leading innovation and the automotive industry. Recorded at Harvard Business School in October 2013.


Case Authors : Linda A. Hill

Topic : Organizational Development

Related Areas : Leadership, Marketing, Organizational culture




Calculating Net Present Value (NPV) at 6% for Luca de Meo Speaks at Harvard Business School Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10006109) -10006109 - -
Year 1 3450141 -6555968 3450141 0.9434 3254850
Year 2 3954179 -2601789 7404320 0.89 3519205
Year 3 3973273 1371484 11377593 0.8396 3336037
Year 4 3235955 4607439 14613548 0.7921 2563179
TOTAL 14613548 12673271




The Net Present Value at 6% discount rate is 2667162

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. Net Present Value
3. Internal Rate of Return
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. Meo Luca 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 Meo Luca have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.






Formula and Steps to Calculate Net Present Value (NPV) of Luca de Meo Speaks at Harvard Business School

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 Meo Luca 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 Meo Luca 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 (10006109) -10006109 - -
Year 1 3450141 -6555968 3450141 0.8696 3000123
Year 2 3954179 -2601789 7404320 0.7561 2989927
Year 3 3973273 1371484 11377593 0.6575 2612491
Year 4 3235955 4607439 14613548 0.5718 1850168
TOTAL 10452709


The Net NPV after 4 years is 446600

(10452709 - 10006109 )








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 (10006109) -10006109 - -
Year 1 3450141 -6555968 3450141 0.8333 2875118
Year 2 3954179 -2601789 7404320 0.6944 2745958
Year 3 3973273 1371484 11377593 0.5787 2299348
Year 4 3235955 4607439 14613548 0.4823 1560549
TOTAL 9480972


The Net NPV after 4 years is -525137

At 20% discount rate the NPV is negative (9480972 - 10006109 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Meo Luca 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 Meo Luca has a NPV value higher than Zero then finance managers at Meo Luca 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 Meo Luca, then the stock price of the Meo Luca 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 Meo Luca 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 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.

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.

Understanding of risks involved in the project.

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 Luca de Meo Speaks at Harvard Business School

References & Further Readings

Linda A. Hill (2018), "Luca de Meo Speaks at Harvard Business School Harvard Business Review Case Study. Published by HBR Publications.


Ameri SWOT Analysis / TOWS Matrix

Technology , Software & Programming


Fuji Corp Ltd SWOT Analysis / TOWS Matrix

Capital Goods , Construction Services


Bel Fuse A SWOT Analysis / TOWS Matrix

Technology , Electronic Instr. & Controls


Gladstone Investment SWOT Analysis / TOWS Matrix

Financial , Misc. Financial Services


Red Star Macalline A SWOT Analysis / TOWS Matrix

Services , Retail (Home Improvement)


Bharat Heavy Electricals SWOT Analysis / TOWS Matrix

Capital Goods , Misc. Capital Goods


Chuetsu Pulp Paper SWOT Analysis / TOWS Matrix

Basic Materials , Paper & Paper Products


Avation PLC SWOT Analysis / TOWS Matrix

Services , Rental & Leasing


Ken SWOT Analysis / TOWS Matrix

Capital Goods , Construction Services


TSR Capital SWOT Analysis / TOWS Matrix

Capital Goods , Construction Services


Focus Tech A SWOT Analysis / TOWS Matrix

Consumer/Non-Cyclical , Personal & Household Prods.