American Constructors Inc.: World Outreach Expansion Project 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 American Constructors Inc.: World Outreach Expansion Project case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. American Constructors Inc.: World Outreach Expansion Project case study is a Harvard Business School (HBR) case study written by Leanne Miele, Kenneth J. Klassen. The American Constructors Inc.: World Outreach Expansion Project (referred as “Project Aci” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Project management, Time management.

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 American Constructors Inc.: World Outreach Expansion Project Case Study

The project manager for American Constructors Inc. (ACI) sat down with his team on September 24, 2009, to evaluate the progress of their building expansion project in Murfreesboro, Tennessee. The team had been working on the World Outreach Church expansion project for over a year already and it was nearing completion. Originally scheduled for completion by March 2010, the project deadline was pushed ahead to December 14, 2009, at the request of the client, who desired to use the property for the Christmas season. In an effort to maintain the reputation of ACI, which had grown to be known as middle Tennessee's premier contractor, the project manager and his team needed to determine if the December 14 deadline was feasible. This case was designed for use in an undergraduate or MBA operations management or introductory project management course. Developed to aid instructors in facilitating discussions of key project management concepts, the case content allows for an analytical approach to covering the basic skills in planning a project, including precedence relationship, critical path, due dates, uncertainty (PERT tasks), crashing, etc. It can be used to teach students the use of MS Project or other project management software. It can also be used for a less analytic, more managerial discussion of project management. During the case discussion, the instructor can bring out points regarding what actually happened (included in the teaching note) that help round out the case discussion.

Case Authors : Leanne Miele, Kenneth J. Klassen

Topic : Technology & Operations

Related Areas : Project management, Time management

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Calculating Net Present Value (NPV) at 6% for American Constructors Inc.: World Outreach Expansion Project Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10022133)	-10022133	-	-
Year 1	3471106	-6551027	3471106	0.9434	3274628
Year 2	3963486	-2587541	7434592	0.89	3527488
Year 3	3961642	1374101	11396234	0.8396	3326271
Year 4	3234128	4608229	14630362	0.7921	2561732
TOTAL			14630362		12690120

The Net Present Value at 6% discount rate is 2667987

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. Profitability Index
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. Project Aci 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 Project Aci 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 American Constructors Inc.: World Outreach Expansion Project

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 Technology & Operations 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 Project Aci 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 Project Aci 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	(10022133)	-10022133	-	-
Year 1	3471106	-6551027	3471106	0.8696	3018353
Year 2	3963486	-2587541	7434592	0.7561	2996965
Year 3	3961642	1374101	11396234	0.6575	2604844
Year 4	3234128	4608229	14630362	0.5718	1849123
TOTAL					10469285

The Net NPV after 4 years is 447152

(10469285 - 10022133 )

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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	(10022133)	-10022133	-	-
Year 1	3471106	-6551027	3471106	0.8333	2892588
Year 2	3963486	-2587541	7434592	0.6944	2752421
Year 3	3961642	1374101	11396234	0.5787	2292617
Year 4	3234128	4608229	14630362	0.4823	1559668
TOTAL					9497294

The Net NPV after 4 years is -524839

At 20% discount rate the NPV is negative (9497294 - 10022133 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Project Aci 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 Project Aci has a NPV value higher than Zero then finance managers at Project Aci 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 Project Aci, then the stock price of the Project Aci 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 Project Aci 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 –

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 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.

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 American Constructors Inc.: World Outreach Expansion Project

References & Further Readings

Leanne Miele, Kenneth J. Klassen (2018), "American Constructors Inc.: World Outreach Expansion Project Harvard Business Review Case Study. Published by HBR Publications.