LeBron James 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 LeBron James case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. LeBron James case study is a Harvard Business School (HBR) case study written by Anita Elberse, Jeff McCall. The LeBron James (referred as “Endorsement James” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Compensation, Entrepreneurship, Talent management.

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 LeBron James Case Study

In 2005, to the astonishment of many sports industry insiders, superstar basketball player LeBron James fired his agent and established his own firm, LRMR, to handle all aspects of his business ventures and marketing activities and named his childhood friend Maverick Carter as the CEO. LRMR is tasked with turning James into a global icon as well as helping him reach his personal goal of becoming basketball's first billionaire. In late 2008, James has entered various lucrative endorsement deals and is considering three exclusive videogame endorsement opportunities from Electronic Arts, 2K Games, and Xbox Live to add to his portfolio. Allows for a rich discussion about how superstar athletes and other celebrities can create and capture value from their brands as well as what role talent agencies and other intermediaries play in that process. Provides in-depth information on three endorsement opportunities that each represents a common way in which talent can (choose to) get compensated: through a fixed-fee payment, a bonus payment structure, or a revenue-sharing agreement.

Case Authors : Anita Elberse, Jeff McCall

Topic : Sales & Marketing

Related Areas : Compensation, Entrepreneurship, Talent management

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Calculating Net Present Value (NPV) at 6% for LeBron James Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10021704)	-10021704	-	-
Year 1	3458722	-6562982	3458722	0.9434	3262945
Year 2	3981436	-2581546	7440158	0.89	3543464
Year 3	3945540	1363994	11385698	0.8396	3312751
Year 4	3240878	4604872	14626576	0.7921	2567079
TOTAL			14626576		12686240

The Net Present Value at 6% discount rate is 2664536

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

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. Endorsement James 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 Endorsement James 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 LeBron James

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 Endorsement James 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 Endorsement James 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	(10021704)	-10021704	-	-
Year 1	3458722	-6562982	3458722	0.8696	3007584
Year 2	3981436	-2581546	7440158	0.7561	3010538
Year 3	3945540	1363994	11385698	0.6575	2594257
Year 4	3240878	4604872	14626576	0.5718	1852983
TOTAL					10465361

The Net NPV after 4 years is 443657

(10465361 - 10021704 )

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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	(10021704)	-10021704	-	-
Year 1	3458722	-6562982	3458722	0.8333	2882268
Year 2	3981436	-2581546	7440158	0.6944	2764886
Year 3	3945540	1363994	11385698	0.5787	2283299
Year 4	3240878	4604872	14626576	0.4823	1562923
TOTAL					9493376

The Net NPV after 4 years is -528328

At 20% discount rate the NPV is negative (9493376 - 10021704 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Endorsement James 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 Endorsement James has a NPV value higher than Zero then finance managers at Endorsement James 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 Endorsement James, then the stock price of the Endorsement James 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 Endorsement James 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 can impact the cash flow of the project.

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 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.

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 LeBron James

References & Further Readings

Anita Elberse, Jeff McCall (2018), "LeBron James Harvard Business Review Case Study. Published by HBR Publications.