Decentralization Is the New Center of Command 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 Decentralization Is the New Center of Command case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Decentralization Is the New Center of Command case study is a Harvard Business School (HBR) case study written by Thomas W. Malone. The Decentralization Is the New Center of Command (referred as “Malone Activities” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Change management, Corporate governance, Organizational structure.

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 Decentralization Is the New Center of Command Case Study

For almost three decades, MIT Professor Thomas W. Malone has been researching the enormous impact of information technology on organizations. Against the backdrop of the global economic downturn, Malone discusses how new forms of communication are increasingly empowering workers, and consequently, loosening the structures of corporate hierarchies. This situation will eventually lead to the widespread use of what he calls the coordinate-and-cultivate approach to management. With this approach, coordination focuses on the activities that need to be done within the firm and the relationships among these activities. Cultivation, meanwhile, focuses on the people doing the activities: what they want, what they're good at, how they can realize their potential. While top-down control is needed at certain times, the author argues that it will also become increasingly imperative to help people find and develop their own natural strengths. Looking at the sweep of human history, the author unearths signs that the business world may be returning to our smaller, loosely constructed, hunter-gatherer roots of yore. This organizational evolution opens up a whole new range of business possibilities, which companies would do well to exploit and embrace before they find themselves the dinosaurs in a new age.

Case Authors : Thomas W. Malone

Topic : Technology & Operations

Related Areas : Change management, Corporate governance, Organizational structure

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Calculating Net Present Value (NPV) at 6% for Decentralization Is the New Center of Command Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10023516)	-10023516	-	-
Year 1	3470268	-6553248	3470268	0.9434	3273838
Year 2	3976610	-2576638	7446878	0.89	3539169
Year 3	3943627	1366989	11390505	0.8396	3311145
Year 4	3249290	4616279	14639795	0.7921	2573742
TOTAL			14639795		12697894

The Net Present Value at 6% discount rate is 2674378

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. Net Present Value
2. Profitability Index
3. Payback Period
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. Malone Activities 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 Malone Activities 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 Decentralization Is the New Center of Command

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 Malone Activities 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 Malone Activities 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	(10023516)	-10023516	-	-
Year 1	3470268	-6553248	3470268	0.8696	3017624
Year 2	3976610	-2576638	7446878	0.7561	3006888
Year 3	3943627	1366989	11390505	0.6575	2592999
Year 4	3249290	4616279	14639795	0.5718	1857792
TOTAL					10475304

The Net NPV after 4 years is 451788

(10475304 - 10023516 )

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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	(10023516)	-10023516	-	-
Year 1	3470268	-6553248	3470268	0.8333	2891890
Year 2	3976610	-2576638	7446878	0.6944	2761535
Year 3	3943627	1366989	11390505	0.5787	2282192
Year 4	3249290	4616279	14639795	0.4823	1566980
TOTAL					9502596

The Net NPV after 4 years is -520920

At 20% discount rate the NPV is negative (9502596 - 10023516 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Malone Activities 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 Malone Activities has a NPV value higher than Zero then finance managers at Malone Activities 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 Malone Activities, then the stock price of the Malone Activities 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 Malone Activities 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 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.

Understanding of risks involved in 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.

What can impact the cash flow of the project.

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 Decentralization Is the New Center of Command

References & Further Readings

Thomas W. Malone (2018), "Decentralization Is the New Center of Command Harvard Business Review Case Study. Published by HBR Publications.