Neighborhood Conservation Services of Barberton: Responding to Change in the Magic City 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 Neighborhood Conservation Services of Barberton: Responding to Change in the Magic City case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Neighborhood Conservation Services of Barberton: Responding to Change in the Magic City case study is a Harvard Business School (HBR) case study written by Howard Husock, David Brown, Christine W. Letts. The Neighborhood Conservation Services of Barberton: Responding to Change in the Magic City (referred as “Barberton Ncs” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Financial management, International business, Organizational structure, Policy, 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 Neighborhood Conservation Services of Barberton: Responding to Change in the Magic City Case Study

In the late 1990s, the leadership of Neighborhood Conservation Services (NCS) of Barberton, Ohio--a nonprofit housing rehabilitation organization founded two decades earlier to help reverse the decline of this aging industrial city--found its once popular mission had suddenly become politically controversial. The long unassailable idea of using public funds to target low-interest loans to lower-income homeowners was being questioned by elected officials in the city of 28,000, officials concerned that limiting loans to those of low-income--in conjunction with a concentration of public housing and rent subsidies--might make Barberton a "magnet" for low-income households. A mayor intent on reviving the city's tax base and attracting and retaining the middle class challenged NCS to demonstrate how its policies could help the city. This new political climate posed a difficult and crucial strategic challenge for the organization--which relied on funds voted by the City Council for the overwhelming majority of its budget. NCS, believed its leadership, would have to find ways to reconcile its mission with the new political climate in town or find a new way to fund its programs--or simply close up shop. This nonprofit management case is meant to allow for discussion of how organizational strategy should adapt to political change. In particular, it raises the question of the extent and nature of the obligation of those receiving public funds to defer to elected officials. The case can also be used in discussion of housing policy per se, to explore the question of when and where housing subsidies are appropriate. HKS Case Number 1707.0

Case Authors : Howard Husock, David Brown, Christine W. Letts

Topic : Strategy & Execution

Related Areas : Financial management, International business, Organizational structure, Policy, Strategic planning

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Calculating Net Present Value (NPV) at 6% for Neighborhood Conservation Services of Barberton: Responding to Change in the Magic City Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10011594)	-10011594	-	-
Year 1	3448471	-6563123	3448471	0.9434	3253275
Year 2	3962141	-2600982	7410612	0.89	3526291
Year 3	3956157	1355175	11366769	0.8396	3321666
Year 4	3231732	4586907	14598501	0.7921	2559834
TOTAL			14598501		12661066

The Net Present Value at 6% discount rate is 2649472

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. Net Present Value
2. Payback Period
3. Internal Rate of Return
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. Timing of the expected cash flows – stockholders of Barberton Ncs 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. Barberton Ncs 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 Neighborhood Conservation Services of Barberton: Responding to Change in the Magic City

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 Barberton Ncs 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 Barberton Ncs 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	(10011594)	-10011594	-	-
Year 1	3448471	-6563123	3448471	0.8696	2998670
Year 2	3962141	-2600982	7410612	0.7561	2995948
Year 3	3956157	1355175	11366769	0.6575	2601237
Year 4	3231732	4586907	14598501	0.5718	1847753
TOTAL					10443609

The Net NPV after 4 years is 432015

(10443609 - 10011594 )

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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	(10011594)	-10011594	-	-
Year 1	3448471	-6563123	3448471	0.8333	2873726
Year 2	3962141	-2600982	7410612	0.6944	2751487
Year 3	3956157	1355175	11366769	0.5787	2289443
Year 4	3231732	4586907	14598501	0.4823	1558513
TOTAL					9473168

The Net NPV after 4 years is -538426

At 20% discount rate the NPV is negative (9473168 - 10011594 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Barberton Ncs 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 Barberton Ncs has a NPV value higher than Zero then finance managers at Barberton Ncs 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 Barberton Ncs, then the stock price of the Barberton Ncs 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 Barberton Ncs 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 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.

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 Neighborhood Conservation Services of Barberton: Responding to Change in the Magic City

References & Further Readings

Howard Husock, David Brown, Christine W. Letts (2018), "Neighborhood Conservation Services of Barberton: Responding to Change in the Magic City Harvard Business Review Case Study. Published by HBR Publications.