Achieving Successful Strategic Transformation 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 Achieving Successful Strategic Transformation case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Achieving Successful Strategic Transformation case study is a Harvard Business School (HBR) case study written by Gerry Johnson, George S. Yip, Manuel Hensmans. The Achieving Successful Strategic Transformation (referred as “Companies Inevitable” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Operations management, Research & development.

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 Achieving Successful Strategic Transformation Case Study

This is an MIT Sloan Management Review article. Companies that are able to radically change their entrenched ways of doing things and then reclaim leading positions in their industries are the exception rather than the rule. Even less common are companies able to anticipate a new set of requirements and mobilize the internal and external resources necessary to meet them. Few companies make the transformation from their old model to a new one willingly. Typically, they begin to search for a new way forward only when they are pushed. This raises two important questions for corporate managers: (1) Is decline inevitable? (2) Do companies really need a financial downturn to galvanize change, or can they adopt new ways of doing things when not under pressure? Management theorists have observed that decline, while perhaps not inevitable, is at least very likely after a period of time. For this reason, the authors argue, it's important for organizations to develop new dynamic capabilities deliberately rather than relying entirely on their historic capabilities. In their attempt to understand what makes for successful organizational transformations, the authors studied 215 of the United Kingdom's largest public companies. The article focuses on three companies that transformed themselves-Cadbury Schweppes in packaged goods, Tesco in grocery retail and Smith & Nephew in medical devices. It compares them with three other companies from similar industries that were also successful but hadn't been required to make a dramatic shift. The authors found that the companies that transformed themselves had three fundamental advantages over their peers. First, they were able to build alternative coalitions with management. Second, they were able to create a tradition of constructively challenging business as usual. And third, they were able to exploit "happy accidents"to make strategic changes. Together these advantages helped them establish a virtuous cycle of strategic transformation.

Case Authors : Gerry Johnson, George S. Yip, Manuel Hensmans

Topic : Strategy & Execution

Related Areas : Operations management, Research & development

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Calculating Net Present Value (NPV) at 6% for Achieving Successful Strategic Transformation Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10024556)	-10024556	-	-
Year 1	3453608	-6570948	3453608	0.9434	3258121
Year 2	3973012	-2597936	7426620	0.89	3535967
Year 3	3946761	1348825	11373381	0.8396	3313777
Year 4	3242757	4591582	14616138	0.7921	2568567
TOTAL			14616138		12676431

The Net Present Value at 6% discount rate is 2651875

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. Payback Period
3. Net Present Value
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Companies Inevitable 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 Companies Inevitable 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 Achieving Successful Strategic Transformation

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 Companies Inevitable 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 Companies Inevitable 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	(10024556)	-10024556	-	-
Year 1	3453608	-6570948	3453608	0.8696	3003137
Year 2	3973012	-2597936	7426620	0.7561	3004168
Year 3	3946761	1348825	11373381	0.6575	2595059
Year 4	3242757	4591582	14616138	0.5718	1854057
TOTAL					10456422

The Net NPV after 4 years is 431866

(10456422 - 10024556 )

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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	(10024556)	-10024556	-	-
Year 1	3453608	-6570948	3453608	0.8333	2878007
Year 2	3973012	-2597936	7426620	0.6944	2759036
Year 3	3946761	1348825	11373381	0.5787	2284005
Year 4	3242757	4591582	14616138	0.4823	1563830
TOTAL					9484878

The Net NPV after 4 years is -539678

At 20% discount rate the NPV is negative (9484878 - 10024556 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Companies Inevitable 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 Companies Inevitable has a NPV value higher than Zero then finance managers at Companies Inevitable 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 Companies Inevitable, then the stock price of the Companies Inevitable 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 Companies Inevitable 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 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 will be a multi year spillover effect of various taxation regulations.

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.

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 Achieving Successful Strategic Transformation

References & Further Readings

Gerry Johnson, George S. Yip, Manuel Hensmans (2018), "Achieving Successful Strategic Transformation Harvard Business Review Case Study. Published by HBR Publications.