×




Bridges to Excellence: Bringing Quality Heath Care to Life 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 Bridges to Excellence: Bringing Quality Heath Care to Life case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Bridges to Excellence: Bringing Quality Heath Care to Life case study is a Harvard Business School (HBR) case study written by Richard Bohmer, Ingrid M. Nembhard, Robert Galvin. The Bridges to Excellence: Bringing Quality Heath Care to Life (referred as “Heath Bridges” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Ethics, Motivating people, Product development, Project 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






Case Description of Bridges to Excellence: Bringing Quality Heath Care to Life Case Study


General Electric launched Bridges to Excellence Diabetes Care Link, a program through which enrolled physicians receive bonuses of up to 10% of their salary for delivering quality care to diabetic patients covered by a participating employer or health plan. A day later, the Wall Street Journal labeled the program a "bribe." The case explores this accusation and the assumption that purchasers and consumers must explicitly pay for quality in heath care. Also allows evaluation of a specific program from design (e.g., financial reward structure) to implementation (e.g., parties involved). The question of scalability arises, as does the criteria by which to judge success.


Case Authors : Richard Bohmer, Ingrid M. Nembhard, Robert Galvin

Topic : Technology & Operations

Related Areas : Ethics, Motivating people, Product development, Project management




Calculating Net Present Value (NPV) at 6% for Bridges to Excellence: Bringing Quality Heath Care to Life Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10018378) -10018378 - -
Year 1 3470624 -6547754 3470624 0.9434 3274174
Year 2 3974504 -2573250 7445128 0.89 3537294
Year 3 3956180 1382930 11401308 0.8396 3321685
Year 4 3222468 4605398 14623776 0.7921 2552496
TOTAL 14623776 12685649




The Net Present Value at 6% discount rate is 2667271

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

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. Heath Bridges 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 Heath Bridges 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 Bridges to Excellence: Bringing Quality Heath Care to Life

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 Heath Bridges 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 Heath Bridges 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 (10018378) -10018378 - -
Year 1 3470624 -6547754 3470624 0.8696 3017934
Year 2 3974504 -2573250 7445128 0.7561 3005296
Year 3 3956180 1382930 11401308 0.6575 2601253
Year 4 3222468 4605398 14623776 0.5718 1842457
TOTAL 10466939


The Net NPV after 4 years is 448561

(10466939 - 10018378 )








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 (10018378) -10018378 - -
Year 1 3470624 -6547754 3470624 0.8333 2892187
Year 2 3974504 -2573250 7445128 0.6944 2760072
Year 3 3956180 1382930 11401308 0.5787 2289456
Year 4 3222468 4605398 14623776 0.4823 1554045
TOTAL 9495760


The Net NPV after 4 years is -522618

At 20% discount rate the NPV is negative (9495760 - 10018378 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Heath Bridges 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 Heath Bridges has a NPV value higher than Zero then finance managers at Heath Bridges 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 Heath Bridges, then the stock price of the Heath Bridges 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 Heath Bridges 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 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 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.

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 Bridges to Excellence: Bringing Quality Heath Care to Life

References & Further Readings

Richard Bohmer, Ingrid M. Nembhard, Robert Galvin (2018), "Bridges to Excellence: Bringing Quality Heath Care to Life Harvard Business Review Case Study. Published by HBR Publications.


Shaanxi Northwest New Tech SWOT Analysis / TOWS Matrix

Basic Materials , Chemical Manufacturing


Leon Tech SWOT Analysis / TOWS Matrix

Services , Communications Services


Ansaldo SWOT Analysis / TOWS Matrix

Technology , Communications Equipment


Ener-Core SWOT Analysis / TOWS Matrix

Services , Waste Management Services


Izumi Co Ltd SWOT Analysis / TOWS Matrix

Services , Retail (Department & Discount)


H.G.Infra Engineering SWOT Analysis / TOWS Matrix

Capital Goods , Construction Services


Auto Italia SWOT Analysis / TOWS Matrix

Services , Retail (Specialty)


CSA SWOT Analysis / TOWS Matrix

Transportation , Water Transportation