How to Catalyze Innovation in Your Organization 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 How to Catalyze Innovation in Your Organization case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. How to Catalyze Innovation in Your Organization case study is a Harvard Business School (HBR) case study written by Rob Cross, Michael Arena, Jonathan Sims, Mary Uhl-Bien. The How to Catalyze Innovation in Your Organization (referred as “Adaptive Space” 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, Labor, Networking.

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 How to Catalyze Innovation in Your Organization Case Study

This is an MIT Sloan Management Review article. While technology giants such as Alphabet Inc., Apple Inc., and Facebook Inc. are lionized for their innovative cultures, other industries struggle with hierarchal organizations that make consistent organic innovation very difficult. Companies try to address this by formalizing innovation processes. However, such programs, when they succeed, often produce only a portion of the growth that most large organizations require.The authors argue that executives need to better support emergent innovation to supplement planned new product or service development activities. Successful service, product, or process innovations within large, complex organizations are, the authors contend, very much a social phenomenon. This is why organizations that are routinely innovative are intentional about enabling individuals to engage and connect in ways that trigger and expand ideas. How can organizations best connect employees in ways that more systematically unleash emergent innovation? The authors'research suggests that part of the answer lies in the power of network structures and the ability of organizations to create what the authors call adaptive space. They define adaptive space as the network and organizational context that allows people, ideas, information, and resources to flow across the organization and spur successful emergent innovation. Adaptive space works by enabling ideas generated in entrepreneurial pockets of an organization to flow into the operational system to generate innovations that lead to growth. Adaptive space within organizations is fluid and can shift based on need. Companies create adaptive space through environments that open up information flows and enrich idea discovery, development, and amplification. That can be done in a number of ways. For example, the nonprofit research corporation Noblis created adaptive space through an internal crowdsourcing initiative, while General Motors has generated adaptive space through events that bring together people from different parts of the organization. Using network analysis and data collected from more than 400 interviews, the authors found that innovation leaders within an organization engaged with experts, influencers, and decision-makers through different phases of an innovation's journey, and in the process managed to substantially expand the impact of their innovation and streamline its acceptance as it moved from concept to implementation. The authors also describe three roles critical for emergent innovation: brokers (who create bridges between different groups), central connectors (who have extensive connections in one cohesive subgroup), and energizers (who generate enthusiasm for new ideas).

Case Authors : Rob Cross, Michael Arena, Jonathan Sims, Mary Uhl-Bien

Topic : Leadership & Managing People

Related Areas : Labor, Networking

---

Calculating Net Present Value (NPV) at 6% for How to Catalyze Innovation in Your Organization Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10027555)	-10027555	-	-
Year 1	3464065	-6563490	3464065	0.9434	3267986
Year 2	3967203	-2596287	7431268	0.89	3530797
Year 3	3950832	1354545	11382100	0.8396	3317195
Year 4	3242179	4596724	14624279	0.7921	2568109
TOTAL			14624279		12684087

The Net Present Value at 6% discount rate is 2656532

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. Net Present Value
2. Internal Rate of Return
3. Profitability Index
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. Adaptive Space 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 Adaptive Space 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 How to Catalyze Innovation in Your Organization

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 Adaptive Space 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 Adaptive Space 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	(10027555)	-10027555	-	-
Year 1	3464065	-6563490	3464065	0.8696	3012230
Year 2	3967203	-2596287	7431268	0.7561	2999775
Year 3	3950832	1354545	11382100	0.6575	2597736
Year 4	3242179	4596724	14624279	0.5718	1853726
TOTAL					10463468

The Net NPV after 4 years is 435913

(10463468 - 10027555 )

---

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	(10027555)	-10027555	-	-
Year 1	3464065	-6563490	3464065	0.8333	2886721
Year 2	3967203	-2596287	7431268	0.6944	2755002
Year 3	3950832	1354545	11382100	0.5787	2286361
Year 4	3242179	4596724	14624279	0.4823	1563551
TOTAL					9491635

The Net NPV after 4 years is -535920

At 20% discount rate the NPV is negative (9491635 - 10027555 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Adaptive Space 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 Adaptive Space has a NPV value higher than Zero then finance managers at Adaptive Space 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 Adaptive Space, then the stock price of the Adaptive Space 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 Adaptive Space 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.

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

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.

---

Negotiation Strategy of How to Catalyze Innovation in Your Organization

References & Further Readings

Rob Cross, Michael Arena, Jonathan Sims, Mary Uhl-Bien (2018), "How to Catalyze Innovation in Your Organization Harvard Business Review Case Study. Published by HBR Publications.