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WestJet: Building a High-Engagement Culture 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 WestJet: Building a High-Engagement Culture case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. WestJet: Building a High-Engagement Culture case study is a Harvard Business School (HBR) case study written by Gerard Seijts, Ken Mark. The WestJet: Building a High-Engagement Culture (referred as “Westjet Westjet's” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Motivating people, 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






Case Description of WestJet: Building a High-Engagement Culture Case Study


WestJet Airlines had achieved a lot. The airline had taken to the skies only 13 years earlier, with three airplanes flying to five destinations. Now, with a market value at more than $2 billion, the carrier had more than 70 Boeing Next Generation 737s, employed 7,000 people and had played host to more than 12 million guests. WestJet's ambition was to become the dominant airline in Canada by 2013 and one of the five most successful international airlines in the world by 2016. Achieving these goals would mean continued expansion in the WestJet organization. How could WestJet continue to build a high engagement culture as it experienced high rates of growth? In April 2009, in light of the company's rosy predictions of further growth and success, WestJet's pilots seemed dissatisfied with elements of the new contract offer. The leadership team had met a crossroad.


Case Authors : Gerard Seijts, Ken Mark

Topic : Organizational Development

Related Areas : Motivating people, Organizational culture, Organizational structure




Calculating Net Present Value (NPV) at 6% for WestJet: Building a High-Engagement Culture Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10019299) -10019299 - -
Year 1 3445699 -6573600 3445699 0.9434 3250659
Year 2 3961060 -2612540 7406759 0.89 3525329
Year 3 3973740 1361200 11380499 0.8396 3336429
Year 4 3245265 4606465 14625764 0.7921 2570554
TOTAL 14625764 12682971




The Net Present Value at 6% discount rate is 2663672

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. Payback Period
2. Net Present Value
3. Internal Rate of Return
4. Profitability Index

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 Westjet Westjet's 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. Westjet Westjet's 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 WestJet: Building a High-Engagement Culture

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 Westjet Westjet's 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 Westjet Westjet's 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 (10019299) -10019299 - -
Year 1 3445699 -6573600 3445699 0.8696 2996260
Year 2 3961060 -2612540 7406759 0.7561 2995130
Year 3 3973740 1361200 11380499 0.6575 2612799
Year 4 3245265 4606465 14625764 0.5718 1855491
TOTAL 10459680


The Net NPV after 4 years is 440381

(10459680 - 10019299 )








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 (10019299) -10019299 - -
Year 1 3445699 -6573600 3445699 0.8333 2871416
Year 2 3961060 -2612540 7406759 0.6944 2750736
Year 3 3973740 1361200 11380499 0.5787 2299618
Year 4 3245265 4606465 14625764 0.4823 1565039
TOTAL 9486809


The Net NPV after 4 years is -532490

At 20% discount rate the NPV is negative (9486809 - 10019299 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Westjet Westjet's 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 Westjet Westjet's has a NPV value higher than Zero then finance managers at Westjet Westjet's 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 Westjet Westjet's, then the stock price of the Westjet Westjet's 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 Westjet Westjet's 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.

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 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.






Negotiation Strategy of WestJet: Building a High-Engagement Culture

References & Further Readings

Gerard Seijts, Ken Mark (2018), "WestJet: Building a High-Engagement Culture Harvard Business Review Case Study. Published by HBR Publications.


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