Beyond Forecasting: Creating New Strategic Narratives 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 Beyond Forecasting: Creating New Strategic Narratives case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Beyond Forecasting: Creating New Strategic Narratives case study is a Harvard Business School (HBR) case study written by Sarah Kaplan, Wanda J. Orlikowski. The Beyond Forecasting: Creating New Strategic Narratives (referred as “Narratives Assumes” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Strategy.

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 Beyond Forecasting: Creating New Strategic Narratives Case Study

One of the great challenges for organizations in the current economy is making strategy under the uncertainties posed by turbulent environments, intensified competition, emerging technologies, shifting customer tastes and regulatory change. Executives often know they must break with the status quo, but there are few signposts indicating the best way forward. Executives have long been exhorted to conduct analyses of internal and external environments and construct scenarios of the future. However, seeing strategy in this way has some serious weaknesses. It assumes that accuracy can be achieved through rigorous analysis and conscientious efforts to overcome individual biases in perception. It also assumes that the process will be relatively frictionless and primarily analytical. But research has found that most forecasting efforts fail to attain the desired precision. To study how managers make strategy in conditions of considerable uncertainty, the authors took an in-depth look at five technology strategy projects inside the Advanced Technology Strategy Group at a communications technology company that was experiencing a period of high industry turbulence. The authors observed managers'struggles to forecast the future and discovered that managers could not imagine new futures for the company without rethinking the past and reconsidering present concerns. A new future could not shape strategic choices unless it was connected in a narrative that showed how it relates to the past and the present. When managers settled on a particular narrative, they could make choices. Strategy making amid volatility thus involves constructing and reconstructing strategic narratives that reimagine the past and present in ways that allow the organization to explore multiple possible futures. In comparing strategy projects, the authors found that the more work managers do to create novel strategic narratives, the more likely they are to explore alternatives that break with the status quo. This is an MIT Sloan Management Review article.

Case Authors : Sarah Kaplan, Wanda J. Orlikowski

Topic : Strategy & Execution

Related Areas : Strategy

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Calculating Net Present Value (NPV) at 6% for Beyond Forecasting: Creating New Strategic Narratives Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10014649)	-10014649	-	-
Year 1	3461457	-6553192	3461457	0.9434	3265525
Year 2	3980851	-2572341	7442308	0.89	3542943
Year 3	3950151	1377810	11392459	0.8396	3316623
Year 4	3248789	4626599	14641248	0.7921	2573345
TOTAL			14641248		12698437

The Net Present Value at 6% discount rate is 2683788

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. Net Present Value
3. Payback Period
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. Narratives Assumes 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 Narratives Assumes 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 Beyond Forecasting: Creating New Strategic Narratives

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 Narratives Assumes 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 Narratives Assumes 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	(10014649)	-10014649	-	-
Year 1	3461457	-6553192	3461457	0.8696	3009963
Year 2	3980851	-2572341	7442308	0.7561	3010095
Year 3	3950151	1377810	11392459	0.6575	2597288
Year 4	3248789	4626599	14641248	0.5718	1857506
TOTAL					10474852

The Net NPV after 4 years is 460203

(10474852 - 10014649 )

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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	(10014649)	-10014649	-	-
Year 1	3461457	-6553192	3461457	0.8333	2884548
Year 2	3980851	-2572341	7442308	0.6944	2764480
Year 3	3950151	1377810	11392459	0.5787	2285967
Year 4	3248789	4626599	14641248	0.4823	1566739
TOTAL					9501733

The Net NPV after 4 years is -512916

At 20% discount rate the NPV is negative (9501733 - 10014649 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Narratives Assumes 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 Narratives Assumes has a NPV value higher than Zero then finance managers at Narratives Assumes 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 Narratives Assumes, then the stock price of the Narratives Assumes 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 Narratives Assumes 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 can impact the cash flow of the project.

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.

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 Beyond Forecasting: Creating New Strategic Narratives

References & Further Readings

Sarah Kaplan, Wanda J. Orlikowski (2018), "Beyond Forecasting: Creating New Strategic Narratives Harvard Business Review Case Study. Published by HBR Publications.