Humana's Bold Goal: 20 Percent Healthier by 2020 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 Humana's Bold Goal: 20 Percent Healthier by 2020 case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Humana's Bold Goal: 20 Percent Healthier by 2020 case study is a Harvard Business School (HBR) case study written by Nancy M. Kane. The Humana's Bold Goal: 20 Percent Healthier by 2020 (referred as “Humana Health” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, 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

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Case Description of Humana's Bold Goal: 20 Percent Healthier by 2020 Case Study

Beginning in 2013, Humana Inc., headquartered in Louisville, Kentucky, pursued a major organizational transformation, from being an insurance company focused on paying claims to becoming a health and well-being company focused on improving the health of its beneficiaries. The company set a "Bold Goal" of improving the health of the communities it served by 20% by 2020. To achieve this new goal, Humana undertook a multiyear redesign and investment of people, processes, and products in order to gain the trust of consumers and providers, and to partner with communities to improve health. The case focuses on community initiatives, where Humana was developing its new role as "convener of conversations," providing leadership infrastructure and partial funding to spark community planning with a wide range of stakeholders and to design and monitor interventions that were tailored to local health improvement. At the same time, Humana remained a publicly-held corporation accountable to its shareholders for revenue growth and financial return. The case protagonist, Andrew Renda, MD, MPH, Director, Bold Goal Measurement, must design and implement a business plan, including leading and lagging performance metrics, that would measure Humana's progress toward its Bold Goal in ways that supported continued investment in community health improvement in Humana's local markets, while satisfying its traditional business constituents. This case can be used in courses on strategy, community health improvement, the corporate role in public health, and other courses exploring the intersection of business and society. It also offers a rich opportunity to explore the research design and measurement challenges associated with evaluating the impact of public health interventions on local communities.

Case Authors : Nancy M. Kane

Topic : Strategy & Execution

Related Areas : Strategic planning

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Calculating Net Present Value (NPV) at 6% for Humana's Bold Goal: 20 Percent Healthier by 2020 Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10029150)	-10029150	-	-
Year 1	3459787	-6569363	3459787	0.9434	3263950
Year 2	3975834	-2593529	7435621	0.89	3538478
Year 3	3949832	1356303	11385453	0.8396	3316355
Year 4	3246158	4602461	14631611	0.7921	2571261
TOTAL			14631611		12690044

The Net Present Value at 6% discount rate is 2660894

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. Net Present Value
3. Profitability Index
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. Timing of the expected cash flows – stockholders of Humana Health 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. Humana Health 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 Humana's Bold Goal: 20 Percent Healthier by 2020

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 Humana Health 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 Humana Health 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	(10029150)	-10029150	-	-
Year 1	3459787	-6569363	3459787	0.8696	3008510
Year 2	3975834	-2593529	7435621	0.7561	3006302
Year 3	3949832	1356303	11385453	0.6575	2597079
Year 4	3246158	4602461	14631611	0.5718	1856001
TOTAL					10467892

The Net NPV after 4 years is 438742

(10467892 - 10029150 )

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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	(10029150)	-10029150	-	-
Year 1	3459787	-6569363	3459787	0.8333	2883156
Year 2	3975834	-2593529	7435621	0.6944	2760996
Year 3	3949832	1356303	11385453	0.5787	2285782
Year 4	3246158	4602461	14631611	0.4823	1565470
TOTAL					9495404

The Net NPV after 4 years is -533746

At 20% discount rate the NPV is negative (9495404 - 10029150 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Humana Health 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 Humana Health has a NPV value higher than Zero then finance managers at Humana Health 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 Humana Health, then the stock price of the Humana Health 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 Humana Health 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.

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

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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.

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 Humana's Bold Goal: 20 Percent Healthier by 2020

References & Further Readings

Nancy M. Kane (2018), "Humana's Bold Goal: 20 Percent Healthier by 2020 Harvard Business Review Case Study. Published by HBR Publications.