×




Universita' Bocconi: Transformation in the New Millennium 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 Universita' Bocconi: Transformation in the New Millennium case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Universita' Bocconi: Transformation in the New Millennium case study is a Harvard Business School (HBR) case study written by Giovanni Gavetti, Anna Canato. The Universita' Bocconi: Transformation in the New Millennium (referred as “Bocconi Bocconi's” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Growth strategy, Influence, Psychology, Strategic planning.

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 Universita' Bocconi: Transformation in the New Millennium Case Study


Since its foundation in 1902, Bocconi has been a teaching institution with a dominant domestic presence. The case examines the currently unfolding attempt at transforming Bocconi University into a research powerhouse with the ambition to build a strong position among Europe's leading business schools. The case offers a detailed analysis of Bocconi's transformational journey, and illustrates the challenges of changing the mindset of a large portion of the faculty.


Case Authors : Giovanni Gavetti, Anna Canato

Topic : Strategy & Execution

Related Areas : Growth strategy, Influence, Psychology, Strategic planning




Calculating Net Present Value (NPV) at 6% for Universita' Bocconi: Transformation in the New Millennium Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10015077) -10015077 - -
Year 1 3459404 -6555673 3459404 0.9434 3263589
Year 2 3976889 -2578784 7436293 0.89 3539417
Year 3 3956614 1377830 11392907 0.8396 3322049
Year 4 3245757 4623587 14638664 0.7921 2570944
TOTAL 14638664 12695999


The Net Present Value at 6% discount rate is 2680922

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. Internal Rate of Return
2. Payback Period
3. Profitability Index
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 Bocconi Bocconi'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. Bocconi Bocconi'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 Universita' Bocconi: Transformation in the New Millennium

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 Strategy & Execution 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 Bocconi Bocconi'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 Bocconi Bocconi'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 (10015077) -10015077 - -
Year 1 3459404 -6555673 3459404 0.8696 3008177
Year 2 3976889 -2578784 7436293 0.7561 3007099
Year 3 3956614 1377830 11392907 0.6575 2601538
Year 4 3245757 4623587 14638664 0.5718 1855772
TOTAL 10472587


The Net NPV after 4 years is 457510

(10472587 - 10015077 )






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 (10015077) -10015077 - -
Year 1 3459404 -6555673 3459404 0.8333 2882837
Year 2 3976889 -2578784 7436293 0.6944 2761728
Year 3 3956614 1377830 11392907 0.5787 2289707
Year 4 3245757 4623587 14638664 0.4823 1565276
TOTAL 9499549


The Net NPV after 4 years is -515528

At 20% discount rate the NPV is negative (9499549 - 10015077 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Bocconi Bocconi'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 Bocconi Bocconi's has a NPV value higher than Zero then finance managers at Bocconi Bocconi'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 Bocconi Bocconi's, then the stock price of the Bocconi Bocconi'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 Bocconi Bocconi'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 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.

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.

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.




References & Further Readings

Giovanni Gavetti, Anna Canato (2018), "Universita' Bocconi: Transformation in the New Millennium Harvard Business Review Case Study. Published by HBR Publications.