Community Blood Center of the Carolinas: Building for a Better Community 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 Community Blood Center of the Carolinas: Building for a Better Community case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Community Blood Center of the Carolinas: Building for a Better Community case study is a Harvard Business School (HBR) case study written by Linda Swayne. The Community Blood Center of the Carolinas: Building for a Better Community (referred as “Blood Cbcc” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Competitive strategy, Marketing, Strategic planning, Strategic thinking.

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 Community Blood Center of the Carolinas: Building for a Better Community Case Study

In early 2010, Martin Grable, President of the Community Blood Center of the Carolinas (CBCC), was ready to move the first community blood center in North Carolina to a new level. In a strategic planning retreat, he asked the Board of Directors to evaluate seven strategic options and provide its expertise to assist in determining the future direction of the center: Increase provision of specialized blood services by 1. Pooling donors for sickle cell patients, 2. Offering cord blood storage, 3. Developing a therapeutic apheresis/transfusion service or 4. Become a Center that provides a reference lab for other blood centers in the region; 5. Improve blood inventory management software utilization for the region's current hospitals so that CBCC became their sole provider of blood; 6. Expand geographically serving more hospitals and patients; or 7. Re-double efforts to increase donations through additional collection sites, improved marketing, more attention to current donors, and so on. Although all of the alternatives were needed by the community, CBCC did not have unlimited resources. Further, health care reform loomed on the horizon. Clearly, to serve the community, CBCC needed to not only survive, but also thrive in the near term. Which of the alternatives would allow achievement of that goal for the newest FDA-licensed community blood center?

Case Authors : Linda Swayne

Topic : Strategy & Execution

Related Areas : Competitive strategy, Marketing, Strategic planning, Strategic thinking

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Calculating Net Present Value (NPV) at 6% for Community Blood Center of the Carolinas: Building for a Better Community Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10001642)	-10001642	-	-
Year 1	3462790	-6538852	3462790	0.9434	3266783
Year 2	3970506	-2568346	7433296	0.89	3533736
Year 3	3954700	1386354	11387996	0.8396	3320442
Year 4	3223403	4609757	14611399	0.7921	2553237
TOTAL			14611399		12674199

The Net Present Value at 6% discount rate is 2672557

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. Net Present Value
4. Payback Period

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 Blood Cbcc 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. Blood Cbcc 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 Community Blood Center of the Carolinas: Building for a Better Community

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 Blood Cbcc 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 Blood Cbcc 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	(10001642)	-10001642	-	-
Year 1	3462790	-6538852	3462790	0.8696	3011122
Year 2	3970506	-2568346	7433296	0.7561	3002273
Year 3	3954700	1386354	11387996	0.6575	2600279
Year 4	3223403	4609757	14611399	0.5718	1842991
TOTAL					10456665

The Net NPV after 4 years is 455023

(10456665 - 10001642 )

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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	(10001642)	-10001642	-	-
Year 1	3462790	-6538852	3462790	0.8333	2885658
Year 2	3970506	-2568346	7433296	0.6944	2757296
Year 3	3954700	1386354	11387996	0.5787	2288600
Year 4	3223403	4609757	14611399	0.4823	1554496
TOTAL					9486050

The Net NPV after 4 years is -515592

At 20% discount rate the NPV is negative (9486050 - 10001642 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Blood Cbcc 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 Blood Cbcc has a NPV value higher than Zero then finance managers at Blood Cbcc 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 Blood Cbcc, then the stock price of the Blood Cbcc 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 Blood Cbcc 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.

Understanding of risks involved in 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.

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 Community Blood Center of the Carolinas: Building for a Better Community

References & Further Readings

Linda Swayne (2018), "Community Blood Center of the Carolinas: Building for a Better Community Harvard Business Review Case Study. Published by HBR Publications.