Growing Pains at Santropol Roulant, Part B: Sustaining and Disseminating the "Magic" 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 Growing Pains at Santropol Roulant, Part B: Sustaining and Disseminating the "Magic" case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Growing Pains at Santropol Roulant, Part B: Sustaining and Disseminating the "Magic" case study is a Harvard Business School (HBR) case study written by Charlotte Cloutier, Fannie Couture. The Growing Pains at Santropol Roulant, Part B: Sustaining and Disseminating the "Magic" (referred as “Roulant Santropol” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Strategy.

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 Growing Pains at Santropol Roulant, Part B: Sustaining and Disseminating the "Magic" Case Study

Supplement to case HEC183. This case examines the challenges faced by a grassroots non-profit struggling to carry out its mission and stabilize its finances in an increasingly competitive and demanding funding environment over a twenty-year period. It examines the issues faced by non-profits as they chart a course for growth despite precarious funding and divergent stakeholder expectations, examining the often difficult and paradoxical decisions that non-profit managers must make to ensure the survival of their organizations. Santropol Roulant (SR) is a small, community-based non-profit offering a meals-on-wheels service to individuals living with a loss of autonomy. Founded in 1995, SR's mission is to provide an important service to the community while enabling young people to gain valuable work and leadership experience. Despite numerous setbacks, many typical of those encountered by grassroots non-profits, SR managed to grow and thrive without compromising its "ethos" and happily celebrated its 20th anniversary in 2015.

Case Authors : Charlotte Cloutier, Fannie Couture

Topic : Leadership & Managing People

Related Areas : Strategy

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Calculating Net Present Value (NPV) at 6% for Growing Pains at Santropol Roulant, Part B: Sustaining and Disseminating the "Magic" Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10023368)	-10023368	-	-
Year 1	3466155	-6557213	3466155	0.9434	3269958
Year 2	3978281	-2578932	7444436	0.89	3540656
Year 3	3959469	1380537	11403905	0.8396	3324447
Year 4	3231170	4611707	14635075	0.7921	2559389
TOTAL			14635075		12694449

The Net Present Value at 6% discount rate is 2671081

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Roulant Santropol 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 Roulant Santropol 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 Growing Pains at Santropol Roulant, Part B: Sustaining and Disseminating the "Magic"

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 Leadership & Managing People 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 Roulant Santropol 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 Roulant Santropol 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	(10023368)	-10023368	-	-
Year 1	3466155	-6557213	3466155	0.8696	3014048
Year 2	3978281	-2578932	7444436	0.7561	3008152
Year 3	3959469	1380537	11403905	0.6575	2603415
Year 4	3231170	4611707	14635075	0.5718	1847432
TOTAL					10473047

The Net NPV after 4 years is 449679

(10473047 - 10023368 )

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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	(10023368)	-10023368	-	-
Year 1	3466155	-6557213	3466155	0.8333	2888463
Year 2	3978281	-2578932	7444436	0.6944	2762695
Year 3	3959469	1380537	11403905	0.5787	2291359
Year 4	3231170	4611707	14635075	0.4823	1558242
TOTAL					9500759

The Net NPV after 4 years is -522609

At 20% discount rate the NPV is negative (9500759 - 10023368 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Roulant Santropol 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 Roulant Santropol has a NPV value higher than Zero then finance managers at Roulant Santropol 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 Roulant Santropol, then the stock price of the Roulant Santropol 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 Roulant Santropol 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 Growing Pains at Santropol Roulant, Part B: Sustaining and Disseminating the "Magic"

References & Further Readings

Charlotte Cloutier, Fannie Couture (2018), "Growing Pains at Santropol Roulant, Part B: Sustaining and Disseminating the "Magic" Harvard Business Review Case Study. Published by HBR Publications.