Flying Light: British Airways Flight 268 (B) 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 Flying Light: British Airways Flight 268 (B) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Flying Light: British Airways Flight 268 (B) case study is a Harvard Business School (HBR) case study written by R. Edward Freeman, Jenny Mead. The Flying Light: British Airways Flight 268 (B) (referred as “British Flying” 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, Government, International business, Leadership, Risk management, Social responsibility, 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 Flying Light: British Airways Flight 268 (B) Case Study

This is a Darden case study.Despite the incident at takeoff, the British Airways pilots, after discussion with the airline engineers at Heathrow Airport in London, decided to continue the flight uninterrupted. Although the plane landed safely in England, the decision to continue flying set off a hailstorm of criticism and sparked tension between the U.S. Federal Aviation Administration and the CAA, the British equivalent. This case discusses the fallout from the incident, and the ramifications of the decision that was made. See also the A case (UV0773).

Case Authors : R. Edward Freeman, Jenny Mead

Topic : Technology & Operations

Related Areas : Ethics, Government, International business, Leadership, Risk management, Social responsibility, Sustainability

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Calculating Net Present Value (NPV) at 6% for Flying Light: British Airways Flight 268 (B) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10013783)	-10013783	-	-
Year 1	3463467	-6550316	3463467	0.9434	3267422
Year 2	3981467	-2568849	7444934	0.89	3543491
Year 3	3969321	1400472	11414255	0.8396	3332718
Year 4	3228003	4628475	14642258	0.7921	2556881
TOTAL			14642258		12700512

The Net Present Value at 6% discount rate is 2686729

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. Internal Rate of Return
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 British Flying 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. British Flying 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 Flying Light: British Airways Flight 268 (B)

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 British Flying 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 British Flying 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	(10013783)	-10013783	-	-
Year 1	3463467	-6550316	3463467	0.8696	3011710
Year 2	3981467	-2568849	7444934	0.7561	3010561
Year 3	3969321	1400472	11414255	0.6575	2609893
Year 4	3228003	4628475	14642258	0.5718	1845621
TOTAL					10477786

The Net NPV after 4 years is 464003

(10477786 - 10013783 )

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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	(10013783)	-10013783	-	-
Year 1	3463467	-6550316	3463467	0.8333	2886223
Year 2	3981467	-2568849	7444934	0.6944	2764908
Year 3	3969321	1400472	11414255	0.5787	2297061
Year 4	3228003	4628475	14642258	0.4823	1556714
TOTAL					9504905

The Net NPV after 4 years is -508878

At 20% discount rate the NPV is negative (9504905 - 10013783 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of British Flying 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 British Flying has a NPV value higher than Zero then finance managers at British Flying 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 British Flying, then the stock price of the British Flying 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 British Flying 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 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.

What can impact the cash flow of 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 Flying Light: British Airways Flight 268 (B)

References & Further Readings

R. Edward Freeman, Jenny Mead (2018), "Flying Light: British Airways Flight 268 (B) Harvard Business Review Case Study. Published by HBR Publications.