Cradle-to-Cradle Design at Herman Miller: Moving Toward Environmental Sustainability 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 Cradle-to-Cradle Design at Herman Miller: Moving Toward Environmental Sustainability case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Cradle-to-Cradle Design at Herman Miller: Moving Toward Environmental Sustainability case study is a Harvard Business School (HBR) case study written by Deishin Lee, Lionel Bony. The Cradle-to-Cradle Design at Herman Miller: Moving Toward Environmental Sustainability (referred as “C2c Protocol” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Strategy, Supply chain, Sustainability.

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 Cradle-to-Cradle Design at Herman Miller: Moving Toward Environmental Sustainability Case Study

Herman Miller, an office furniture supplier, decided to implement the cradle-to-cradle (C2C) design protocol during the design of its mid-level office chair, Mirra. The C2C protocol was a set of environmentally friendly product development guidelines created by architect William McDonough and chemist Michael Braungart. The essence of this protocol was to eliminate waste and potentially harmful materials by designing the product so that, at the end of its useful life, the raw materials could be fed back into either a technical or biological cycle and used for the same or other purposes. Therefore, materials remained in a closed-loop, eliminating the need for landfill and other toxic forms of disposal such as incineration. The case describes the C2C protocol, the details of how Herman Miller implemented C2C during the design of the Mirra chair, as well as the impact of the new protocol on their internal processes: design decisions, manufacturing, and supply chain management. The proximate decision point in the case is whether the company should replace the polyvinyl chloride (PVC) material in the arm pads of the Mirra chair. PVC was a highly toxic material to manufacture and dispose of and thus violated the C2C protocol. However, it was the standard material for arm pads and many other parts in the office furniture industry as it was durable, scratch resistant, and inexpensive. To switch to thermoplastic urethane (TPU), a more environmentally friendly material, for the Mirra Chair arm pad required at least modification of a production tool, or possibly a completely new tool. In addition, the cost of TPU was higher than PVC. There was also uncertainty about how consistent the quality of the arm pad would be with TPU.

Case Authors : Deishin Lee, Lionel Bony

Topic : Technology & Operations

Related Areas : Strategy, Supply chain, Sustainability

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Calculating Net Present Value (NPV) at 6% for Cradle-to-Cradle Design at Herman Miller: Moving Toward Environmental Sustainability Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10027892)	-10027892	-	-
Year 1	3447389	-6580503	3447389	0.9434	3252254
Year 2	3979446	-2601057	7426835	0.89	3541693
Year 3	3969448	1368391	11396283	0.8396	3332825
Year 4	3250924	4619315	14647207	0.7921	2575036
TOTAL			14647207		12701808

The Net Present Value at 6% discount rate is 2673916

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

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 C2c Protocol 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. C2c Protocol 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 Cradle-to-Cradle Design at Herman Miller: Moving Toward Environmental Sustainability

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 C2c Protocol 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 C2c Protocol 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	(10027892)	-10027892	-	-
Year 1	3447389	-6580503	3447389	0.8696	2997730
Year 2	3979446	-2601057	7426835	0.7561	3009033
Year 3	3969448	1368391	11396283	0.6575	2609976
Year 4	3250924	4619315	14647207	0.5718	1858726
TOTAL					10475465

The Net NPV after 4 years is 447573

(10475465 - 10027892 )

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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	(10027892)	-10027892	-	-
Year 1	3447389	-6580503	3447389	0.8333	2872824
Year 2	3979446	-2601057	7426835	0.6944	2763504
Year 3	3969448	1368391	11396283	0.5787	2297134
Year 4	3250924	4619315	14647207	0.4823	1567768
TOTAL					9501231

The Net NPV after 4 years is -526661

At 20% discount rate the NPV is negative (9501231 - 10027892 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of C2c Protocol 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 C2c Protocol has a NPV value higher than Zero then finance managers at C2c Protocol 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 C2c Protocol, then the stock price of the C2c Protocol 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 C2c Protocol 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.

What will be a multi year spillover effect of various taxation regulations.

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.

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 Cradle-to-Cradle Design at Herman Miller: Moving Toward Environmental Sustainability

References & Further Readings

Deishin Lee, Lionel Bony (2018), "Cradle-to-Cradle Design at Herman Miller: Moving Toward Environmental Sustainability Harvard Business Review Case Study. Published by HBR Publications.