Holt Lunsford Commercial 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 Holt Lunsford Commercial case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Holt Lunsford Commercial case study is a Harvard Business School (HBR) case study written by Arthur I Segel, John H. Vogel Jr.. The Holt Lunsford Commercial (referred as “Lunsford Holt” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Entrepreneurial management, Financial management, Negotiations, Organizational culture.

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 Holt Lunsford Commercial Case Study

Holt Lunsford is debating how to grow his Dallas-based commercial real estate services firm and how to advise a long-time client who is wondering whether to lease or buy an industrial warehouse. Focuses on the highly competitive and increasingly institutionalized $50 billion real estate services industry, which encompasses property management, leasing, tenant representation, and other activities. What makes Lunsford's firm, The Holt Companies, special? Explores what corporate strategy Lunsford should choose for his firm, and what recommendation he should make to his client.

Case Authors : Arthur I Segel, John H. Vogel Jr.

Topic : Strategy & Execution

Related Areas : Entrepreneurial management, Financial management, Negotiations, Organizational culture

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Calculating Net Present Value (NPV) at 6% for Holt Lunsford Commercial Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016873)	-10016873	-	-
Year 1	3472939	-6543934	3472939	0.9434	3276358
Year 2	3959889	-2584045	7432828	0.89	3524287
Year 3	3967692	1383647	11400520	0.8396	3331351
Year 4	3225912	4609559	14626432	0.7921	2555224
TOTAL			14626432		12687220

The Net Present Value at 6% discount rate is 2670347

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Lunsford Holt 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 Lunsford Holt 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 Holt Lunsford Commercial

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 Lunsford Holt 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 Lunsford Holt 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	(10016873)	-10016873	-	-
Year 1	3472939	-6543934	3472939	0.8696	3019947
Year 2	3959889	-2584045	7432828	0.7561	2994245
Year 3	3967692	1383647	11400520	0.6575	2608822
Year 4	3225912	4609559	14626432	0.5718	1844426
TOTAL					10467439

The Net NPV after 4 years is 450566

(10467439 - 10016873 )

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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	(10016873)	-10016873	-	-
Year 1	3472939	-6543934	3472939	0.8333	2894116
Year 2	3959889	-2584045	7432828	0.6944	2749923
Year 3	3967692	1383647	11400520	0.5787	2296118
Year 4	3225912	4609559	14626432	0.4823	1555706
TOTAL					9495863

The Net NPV after 4 years is -521010

At 20% discount rate the NPV is negative (9495863 - 10016873 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Lunsford Holt 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 Lunsford Holt has a NPV value higher than Zero then finance managers at Lunsford Holt 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 Lunsford Holt, then the stock price of the Lunsford Holt 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 Lunsford Holt 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.

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 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 Holt Lunsford Commercial

References & Further Readings

Arthur I Segel, John H. Vogel Jr. (2018), "Holt Lunsford Commercial Harvard Business Review Case Study. Published by HBR Publications.