Lincoln Financial Group (B): Making LFD a Reality, Spanish Version 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 Lincoln Financial Group (B): Making LFD a Reality, Spanish Version case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Lincoln Financial Group (B): Making LFD a Reality, Spanish Version case study is a Harvard Business School (HBR) case study written by David B. Godes, David Lane. The Lincoln Financial Group (B): Making LFD a Reality, Spanish Version (referred as “Salespeople Lfd” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Developing employees, Marketing, Organizational structure, 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 Lincoln Financial Group (B): Making LFD a Reality, Spanish Version Case Study

LFG reorganizes its business in order to improve customer intimacy. However, to implement the strategy, they need to effect significant changes in the skills of their salespeople. This case series straddles human resource management, corporate strategy, and sales management by exploring the link between a shift in the firm's overall strategy (customer intimacy), the structural implementation of this strategy in the form of the creation of a new distribution company and, finally, the transformation of the selling approach through skills assessment and development. The (A) case describes the firm's strategic position as the "manufacturer" of three primary product lines--annuities, insurance, and mutual funds--which they sell to banks, broker/dealers, and independent planners. Most of their customers have just one of these products 'on the shelf.' In 2000, they create Lincoln Financial Distributors (LFD) which will be responsible for the wholesaling of all of these products. The case ends by asking the students to (a) react to this idea and (b) formulate a plan for its implementation. Simply taking salespeople away from their product group and housing them side-by-side with other salespeople selling other products is unlikely to create true customer intimacy. Wes Thompson, LFD's President and Kim Miner, the Human Resources VP, undertake a sweeping effort in which they create a "competency model," denoting precisely what they want their salespeople to be good at, assessing the sales force on these dimensions, and then hiring or training in order to get where they want to be. The (B) case provides rich detail of the model, the assessment approach and the results of the assessments. As the (C) case lays out, the results are stunning in terms of their relationships as well as from a financial perspective. The (C) then ends by offering a strategy for "Act II'" significantly expanding the number of salespeople at LFD.

Case Authors : David B. Godes, David Lane

Topic : Sales & Marketing

Related Areas : Developing employees, Marketing, Organizational structure, Sales

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Calculating Net Present Value (NPV) at 6% for Lincoln Financial Group (B): Making LFD a Reality, Spanish Version Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016635)	-10016635	-	-
Year 1	3453315	-6563320	3453315	0.9434	3257844
Year 2	3956387	-2606933	7409702	0.89	3521170
Year 3	3967538	1360605	11377240	0.8396	3331221
Year 4	3229737	4590342	14606977	0.7921	2558254
TOTAL			14606977		12668490

The Net Present Value at 6% discount rate is 2651855

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. Internal Rate of Return
3. Payback Period
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 Salespeople Lfd 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. Salespeople Lfd 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 Lincoln Financial Group (B): Making LFD a Reality, Spanish Version

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 Sales & Marketing 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 Salespeople Lfd 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 Salespeople Lfd 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	(10016635)	-10016635	-	-
Year 1	3453315	-6563320	3453315	0.8696	3002883
Year 2	3956387	-2606933	7409702	0.7561	2991597
Year 3	3967538	1360605	11377240	0.6575	2608721
Year 4	3229737	4590342	14606977	0.5718	1846613
TOTAL					10449813

The Net NPV after 4 years is 433178

(10449813 - 10016635 )

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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	(10016635)	-10016635	-	-
Year 1	3453315	-6563320	3453315	0.8333	2877763
Year 2	3956387	-2606933	7409702	0.6944	2747491
Year 3	3967538	1360605	11377240	0.5787	2296029
Year 4	3229737	4590342	14606977	0.4823	1557551
TOTAL					9478833

The Net NPV after 4 years is -537802

At 20% discount rate the NPV is negative (9478833 - 10016635 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Salespeople Lfd 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 Salespeople Lfd has a NPV value higher than Zero then finance managers at Salespeople Lfd 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 Salespeople Lfd, then the stock price of the Salespeople Lfd 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 Salespeople Lfd 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 will be a multi year spillover effect of various taxation regulations.

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 Lincoln Financial Group (B): Making LFD a Reality, Spanish Version

References & Further Readings

David B. Godes, David Lane (2018), "Lincoln Financial Group (B): Making LFD a Reality, Spanish Version Harvard Business Review Case Study. Published by HBR Publications.