Defining Torture in the War on Terror (B): The Trail of the 'Torture Memo' 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 Defining Torture in the War on Terror (B): The Trail of the 'Torture Memo' case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Defining Torture in the War on Terror (B): The Trail of the 'Torture Memo' case study is a Harvard Business School (HBR) case study written by Esther Scott, Philip Heymann. The Defining Torture in the War on Terror (B): The Trail of the 'Torture Memo' (referred as “Torture Detainees” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Leadership, Operations management, Regulation, Security & privacy, Social responsibility.

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 Defining Torture in the War on Terror (B): The Trail of the 'Torture Memo' Case Study

After the September 11, 2001, attacks on the United States, President George W. Bush launched a military offensive in Afghanistan, which led to the capture of Al Qaeda operatives thought to be behind the attacks. Top US officials debated how to extract crucial information from them about Al Qaeda's future plans. The Central Intelligence Agency wanted to apply aggressive interrogation methods, which it argued were necessary to convince detainees to reveal what they knew. But CIA officials worried such techniques might violate both international treaties banning torture and "cruel, inhuman or degrading" treatment of prisoners of war and detainees and, more consequentially, the domestic laws that enforced them. To protect its agents, the CIA sought a clear statement from the Bush Administration on how far agents could go in efforts to force detainees to talk. These cases tell the story of OLC's legal findings and their consequences. Part A (1853.0)describes a series of OLC memoranda on the treatment of detainees in the "war on terror," culminating in an August 2002 opinion that became known as the "torture memo," which narrowly interpreted the legal meaning of torture but took a broad view of presidential wartime powers under the Constitution. Part A ends as Assistant Attorney General and OLC head Jay Bybee must decide whether to sign the opinion. Part B (1854.0) tracks the results of the torture memo, tracing the use of interrogation techniques it sanctioned from CIA detention centers overseas to the naval base in Guantanamo Bay, Cuba. In the view of some, these harsher techniques eventually "migrated" to Abu Ghraib prison in Iraq, where abusive treatment of detainees became an international embarrassment for the US. HKS Case Number 1854.0

Case Authors : Esther Scott, Philip Heymann

Topic : Strategy & Execution

Related Areas : Leadership, Operations management, Regulation, Security & privacy, Social responsibility

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Calculating Net Present Value (NPV) at 6% for Defining Torture in the War on Terror (B): The Trail of the 'Torture Memo' Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10028186)	-10028186	-	-
Year 1	3468982	-6559204	3468982	0.9434	3272625
Year 2	3963913	-2595291	7432895	0.89	3527868
Year 3	3939920	1344629	11372815	0.8396	3308033
Year 4	3244436	4589065	14617251	0.7921	2569897
TOTAL			14617251		12678423

The Net Present Value at 6% discount rate is 2650237

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. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Torture Detainees 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 Torture Detainees 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 Defining Torture in the War on Terror (B): The Trail of the 'Torture Memo'

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 Torture Detainees 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 Torture Detainees 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	(10028186)	-10028186	-	-
Year 1	3468982	-6559204	3468982	0.8696	3016506
Year 2	3963913	-2595291	7432895	0.7561	2997288
Year 3	3939920	1344629	11372815	0.6575	2590561
Year 4	3244436	4589065	14617251	0.5718	1855017
TOTAL					10459372

The Net NPV after 4 years is 431186

(10459372 - 10028186 )

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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	(10028186)	-10028186	-	-
Year 1	3468982	-6559204	3468982	0.8333	2890818
Year 2	3963913	-2595291	7432895	0.6944	2752717
Year 3	3939920	1344629	11372815	0.5787	2280046
Year 4	3244436	4589065	14617251	0.4823	1564639
TOTAL					9488221

The Net NPV after 4 years is -539965

At 20% discount rate the NPV is negative (9488221 - 10028186 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Torture Detainees 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 Torture Detainees has a NPV value higher than Zero then finance managers at Torture Detainees 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 Torture Detainees, then the stock price of the Torture Detainees 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 Torture Detainees 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.

What can impact the cash flow of the project.

What will be a multi year spillover effect of various taxation regulations.

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.

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 Defining Torture in the War on Terror (B): The Trail of the 'Torture Memo'

References & Further Readings

Esther Scott, Philip Heymann (2018), "Defining Torture in the War on Terror (B): The Trail of the 'Torture Memo' Harvard Business Review Case Study. Published by HBR Publications.