How to Change an Organization Without Blowing It Up 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 How to Change an Organization Without Blowing It Up case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. How to Change an Organization Without Blowing It Up case study is a Harvard Business School (HBR) case study written by Karen Golden-Biddle. The How to Change an Organization Without Blowing It Up (referred as “Disconnects Transformation” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Leadership.

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

---

Case Description of How to Change an Organization Without Blowing It Up Case Study

This is an MIT Sloan Management Review article. Too often, conventional approaches to organizational transformation resemble the Big Bang theory. Change occurs all at once, on a large scale, and often in response to crisis. Yet we know from a great deal of experience that Big Bang transformation attempts often fail, fostering employee discontent and producing mediocre solutions with little lasting impact. Instead of undertaking a risky, large-scale makeover, organizations can seed transformation by collectively uncovering "everyday disconnects"-the disparities between our expectations about how work is carried out and how it is actually is. The discovery of such disconnects encourages people to think about how the work might be done differently. Continuously pursuing these smaller-scale changes -and then weaving them together -offers a practical middle path between large-scale transformation and smallscale pilot projects that run the risk of producing too little too late. The author has found that organizations take three approaches to discovery that are both particularly effective for uncovering everyday disconnects in the organization's work and seeding transformation from the bottom up. These techniques can be used together. The three techniques are: 1. Work Discovery Instead of assuming that you know how work is designed, examine it firsthand as it is actually conducted. Determine how to turn the (inevitable) surprises you uncover into assets. 2. Better Practices Instead of simply adopting the best practices of other organizations, screen the way work gets done in your organization through those best practices to generate new ideas. In other words, use best practices to generate even better practices. 3. Test Training Instead of locking down standard operating procedures during training, experiment with other, potentially better possibilities for changing the way the work will get done. Use training for testing these possibilities.

Case Authors : Karen Golden-Biddle

Topic : Strategy & Execution

Related Areas : Leadership

---

Calculating Net Present Value (NPV) at 6% for How to Change an Organization Without Blowing It Up Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019085)	-10019085	-	-
Year 1	3470852	-6548233	3470852	0.9434	3274389
Year 2	3963538	-2584695	7434390	0.89	3527535
Year 3	3963641	1378946	11398031	0.8396	3327949
Year 4	3229915	4608861	14627946	0.7921	2558395
TOTAL			14627946		12688268

The Net Present Value at 6% discount rate is 2669183

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.

---

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. Profitability Index
3. Payback Period
4. Net Present Value

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. Disconnects Transformation 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 Disconnects Transformation have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

---

Formula and Steps to Calculate Net Present Value (NPV) of How to Change an Organization Without Blowing It Up

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 Disconnects Transformation 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 Disconnects Transformation 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	(10019085)	-10019085	-	-
Year 1	3470852	-6548233	3470852	0.8696	3018132
Year 2	3963538	-2584695	7434390	0.7561	2997004
Year 3	3963641	1378946	11398031	0.6575	2606158
Year 4	3229915	4608861	14627946	0.5718	1846714
TOTAL					10468009

The Net NPV after 4 years is 448924

(10468009 - 10019085 )

---

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	(10019085)	-10019085	-	-
Year 1	3470852	-6548233	3470852	0.8333	2892377
Year 2	3963538	-2584695	7434390	0.6944	2752457
Year 3	3963641	1378946	11398031	0.5787	2293774
Year 4	3229915	4608861	14627946	0.4823	1557636
TOTAL					9496244

The Net NPV after 4 years is -522841

At 20% discount rate the NPV is negative (9496244 - 10019085 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Disconnects Transformation 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 Disconnects Transformation has a NPV value higher than Zero then finance managers at Disconnects Transformation 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 Disconnects Transformation, then the stock price of the Disconnects Transformation 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 Disconnects Transformation 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.

Understanding of risks involved in the project.

What can impact the cash flow of the project.

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.

---

Negotiation Strategy of How to Change an Organization Without Blowing It Up

References & Further Readings

Karen Golden-Biddle (2018), "How to Change an Organization Without Blowing It Up Harvard Business Review Case Study. Published by HBR Publications.