Wendy Peterson 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 Wendy Peterson case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Wendy Peterson case study is a Harvard Business School (HBR) case study written by Linda A. Hill, Alisa Zalosh. The Wendy Peterson (referred as “Peterson Wu” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Assessing performance, Conflict, Cross-cultural management, Developing employees, Leadership, Sales.

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 Wendy Peterson Case Study

Wendy Peterson was recently promoted to Vice President of Sales at the Plano, Texas, office of AccountBack, an accounting software and services company. To penetrate a perceived market niche, Peterson hires Fred (Xing) Wu, whose familiarity with and access to Chinese business leaders in Plano is valuable. Wu was born and raised in China, partly educated in the U.S., and immigrated to the U.S. in 2005. Within 12 months, he had signed his regional team's largest client, but Peterson has reservations about Wu's performance and is uneasy about their working relationship. Wu has requested an assistant-unprecedented within AccountBack's flat organizational structure. Peterson reflexively perceives the request as unreasonable, but in responding she must take into account the implications her decision will have on the rest of her sales team, as well as her own career. This case is ideal for courses on managing performance, managing conflict, leadership, cross-cultural differences, conflict and negotiation, employee development, and performance evaluation.

Case Authors : Linda A. Hill, Alisa Zalosh

Topic : Organizational Development

Related Areas : Assessing performance, Conflict, Cross-cultural management, Developing employees, Leadership, Sales

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Calculating Net Present Value (NPV) at 6% for Wendy Peterson Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10025333)	-10025333	-	-
Year 1	3443575	-6581758	3443575	0.9434	3248656
Year 2	3977460	-2604298	7421035	0.89	3539925
Year 3	3966498	1362200	11387533	0.8396	3330348
Year 4	3234327	4596527	14621860	0.7921	2561890
TOTAL			14621860		12680819

The Net Present Value at 6% discount rate is 2655486

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. Internal Rate of Return
2. Profitability Index
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. Peterson Wu 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 Peterson Wu 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 Wendy Peterson

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 Peterson Wu 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 Peterson Wu 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	(10025333)	-10025333	-	-
Year 1	3443575	-6581758	3443575	0.8696	2994413
Year 2	3977460	-2604298	7421035	0.7561	3007531
Year 3	3966498	1362200	11387533	0.6575	2608037
Year 4	3234327	4596527	14621860	0.5718	1849237
TOTAL					10459218

The Net NPV after 4 years is 433885

(10459218 - 10025333 )

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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	(10025333)	-10025333	-	-
Year 1	3443575	-6581758	3443575	0.8333	2869646
Year 2	3977460	-2604298	7421035	0.6944	2762125
Year 3	3966498	1362200	11387533	0.5787	2295427
Year 4	3234327	4596527	14621860	0.4823	1559764
TOTAL					9486962

The Net NPV after 4 years is -538371

At 20% discount rate the NPV is negative (9486962 - 10025333 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Peterson Wu 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 Peterson Wu has a NPV value higher than Zero then finance managers at Peterson Wu 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 Peterson Wu, then the stock price of the Peterson Wu 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 Peterson Wu 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 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.

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.

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 Wendy Peterson

References & Further Readings

Linda A. Hill, Alisa Zalosh (2018), "Wendy Peterson Harvard Business Review Case Study. Published by HBR Publications.