Three Cultures of Management: The Key to Organizational Learning 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 Three Cultures of Management: The Key to Organizational Learning case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Three Cultures of Management: The Key to Organizational Learning case study is a Harvard Business School (HBR) case study written by Edgar H. Schein. The Three Cultures of Management: The Key to Organizational Learning (referred as “Cultures Culture” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Innovation, Knowledge management, Leadership, Organizational culture, Organizational structure.

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 Three Cultures of Management: The Key to Organizational Learning Case Study

This is an MIT Sloan Management Review article. Why do so many organizations fail to learn? According to the author, such failures may be caused not by resistance to change, human nature, or poor leadership, but by the lack of communication among three cultures: operating, engineering, and executive. The culture of operators is based on human interaction. Operators may use their learning ability to thwart management's efforts to improve productivity. The engineering culture represents the design elements of the technology underlying the organization and how the technology is to be used. The executive culture revolves around maintaining an organization's financial health and deals with boards, investors, and capital markets. According to the author, when organizations attempt to redesign or reinvent themselves, the cultures collide and failure occurs. Executives and engineers are task focused and assume that people are the problem. Executives band together and depersonalize their employees. Executives and engineers can't agree on how to make organizations work better while keeping costs down. Each culture must learn how to learn and to analyze its own culture. Then enough mutual understanding must be created among the cultures to evolve solutions that all groups can commit to.

Case Authors : Edgar H. Schein

Topic : Organizational Development

Related Areas : Innovation, Knowledge management, Leadership, Organizational culture, Organizational structure

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Calculating Net Present Value (NPV) at 6% for Three Cultures of Management: The Key to Organizational Learning Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10021387)	-10021387	-	-
Year 1	3449581	-6571806	3449581	0.9434	3254322
Year 2	3967680	-2604126	7417261	0.89	3531221
Year 3	3963287	1359161	11380548	0.8396	3327652
Year 4	3227901	4587062	14608449	0.7921	2556800
TOTAL			14608449		12669995

The Net Present Value at 6% discount rate is 2648608

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. Payback Period
3. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Cultures Culture 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 Cultures Culture 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 Three Cultures of Management: The Key to Organizational Learning

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 Cultures Culture 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 Cultures Culture 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	(10021387)	-10021387	-	-
Year 1	3449581	-6571806	3449581	0.8696	2999636
Year 2	3967680	-2604126	7417261	0.7561	3000136
Year 3	3963287	1359161	11380548	0.6575	2605926
Year 4	3227901	4587062	14608449	0.5718	1845563
TOTAL					10451260

The Net NPV after 4 years is 429873

(10451260 - 10021387 )

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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	(10021387)	-10021387	-	-
Year 1	3449581	-6571806	3449581	0.8333	2874651
Year 2	3967680	-2604126	7417261	0.6944	2755333
Year 3	3963287	1359161	11380548	0.5787	2293569
Year 4	3227901	4587062	14608449	0.4823	1556665
TOTAL					9480218

The Net NPV after 4 years is -541169

At 20% discount rate the NPV is negative (9480218 - 10021387 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Cultures Culture 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 Cultures Culture has a NPV value higher than Zero then finance managers at Cultures Culture 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 Cultures Culture, then the stock price of the Cultures Culture 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 Cultures Culture 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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in 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 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 Three Cultures of Management: The Key to Organizational Learning

References & Further Readings

Edgar H. Schein (2018), "Three Cultures of Management: The Key to Organizational Learning Harvard Business Review Case Study. Published by HBR Publications.