Communications Policy 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 Communications Policy case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Communications Policy case study is a Harvard Business School (HBR) case study written by Stephen H. Star. The Communications Policy (referred as “Communications Delineation” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Marketing, Public relations, 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 Communications Policy Case Study

Introductory note on communications policy for use in first year marketing. Focuses on: Target selection; message delineation; communications intensity; alternative communications; means and media; economics of communications decisions; and need for consistency in communications programs. Assumes that students have previously read Consumer Analysis, Market Analysis, and Note on Marketing Arithmetic and Related Marketing Terms.

Case Authors : Stephen H. Star

Topic : Sales & Marketing

Related Areas : Marketing, Public relations, Sales

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Calculating Net Present Value (NPV) at 6% for Communications Policy Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10005243)	-10005243	-	-
Year 1	3447608	-6557635	3447608	0.9434	3252460
Year 2	3976719	-2580916	7424327	0.89	3539266
Year 3	3964900	1383984	11389227	0.8396	3329006
Year 4	3233836	4617820	14623063	0.7921	2561501
TOTAL			14623063		12682234

The Net Present Value at 6% discount rate is 2676991

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. Payback Period
3. Net Present Value
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 Communications Delineation 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. Communications Delineation 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 Communications Policy

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 Communications Delineation 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 Communications Delineation 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	(10005243)	-10005243	-	-
Year 1	3447608	-6557635	3447608	0.8696	2997920
Year 2	3976719	-2580916	7424327	0.7561	3006971
Year 3	3964900	1383984	11389227	0.6575	2606986
Year 4	3233836	4617820	14623063	0.5718	1848956
TOTAL					10460833

The Net NPV after 4 years is 455590

(10460833 - 10005243 )

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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	(10005243)	-10005243	-	-
Year 1	3447608	-6557635	3447608	0.8333	2873007
Year 2	3976719	-2580916	7424327	0.6944	2761610
Year 3	3964900	1383984	11389227	0.5787	2294502
Year 4	3233836	4617820	14623063	0.4823	1559527
TOTAL					9488647

The Net NPV after 4 years is -516596

At 20% discount rate the NPV is negative (9488647 - 10005243 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Communications Delineation 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 Communications Delineation has a NPV value higher than Zero then finance managers at Communications Delineation 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 Communications Delineation, then the stock price of the Communications Delineation 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 Communications Delineation 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 –

Understanding of risks involved in the project.

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.

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 Communications Policy

References & Further Readings

Stephen H. Star (2018), "Communications Policy Harvard Business Review Case Study. Published by HBR Publications.