Royal Bank of Canada: Using People Strategy and Analytics to Drive Employee Performance (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 Royal Bank of Canada: Using People Strategy and Analytics to Drive Employee Performance (B) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Royal Bank of Canada: Using People Strategy and Analytics to Drive Employee Performance (B) case study is a Harvard Business School (HBR) case study written by Debra Schifrin, Kathryn Shaw. The Royal Bank of Canada: Using People Strategy and Analytics to Drive Employee Performance (B) (referred as “Analytics Royal” from here on) case study provides evaluation & decision scenario in field of Communication. It also touches upon business topics such as - Value proposition, Career planning, Change management, Compensation, Human resource management, Organizational culture, 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 Royal Bank of Canada: Using People Strategy and Analytics to Drive Employee Performance (B) Case Study

Supplement to case HR44A. This is the follow up case to "Royal Bank of Canada: Using People Strategy and Analytics to Drive Employee Performance (A)." This (B) case presents the results of the company's two major people analytics projects, which are described in the (A) case. The first project used data to identify empirically the traits of great managers and subsequently identify who might or might not be a great manager. This enabled RBC to help those managers who could benefit from coaching or other types of interventions. The second project used both internal and customer data to diagnose whether any specific branch, region, or product innovation was not doing as well as it could be-and why not.

Case Authors : Debra Schifrin, Kathryn Shaw

Topic : Communication

Related Areas : Career planning, Change management, Compensation, Human resource management, Organizational culture, Strategy

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Calculating Net Present Value (NPV) at 6% for Royal Bank of Canada: Using People Strategy and Analytics to Drive Employee Performance (B) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10029659)	-10029659	-	-
Year 1	3451491	-6578168	3451491	0.9434	3256124
Year 2	3974243	-2603925	7425734	0.89	3537062
Year 3	3971336	1367411	11397070	0.8396	3334410
Year 4	3235856	4603267	14632926	0.7921	2563101
TOTAL			14632926		12690697

The Net Present Value at 6% discount rate is 2661038

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. Profitability Index
2. Net Present Value
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. Analytics Royal 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 Analytics Royal 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 Royal Bank of Canada: Using People Strategy and Analytics to Drive Employee Performance (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 Communication 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 Analytics Royal 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 Analytics Royal 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	(10029659)	-10029659	-	-
Year 1	3451491	-6578168	3451491	0.8696	3001297
Year 2	3974243	-2603925	7425734	0.7561	3005099
Year 3	3971336	1367411	11397070	0.6575	2611218
Year 4	3235856	4603267	14632926	0.5718	1850111
TOTAL					10467724

The Net NPV after 4 years is 438065

(10467724 - 10029659 )

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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	(10029659)	-10029659	-	-
Year 1	3451491	-6578168	3451491	0.8333	2876243
Year 2	3974243	-2603925	7425734	0.6944	2759891
Year 3	3971336	1367411	11397070	0.5787	2298227
Year 4	3235856	4603267	14632926	0.4823	1560502
TOTAL					9494862

The Net NPV after 4 years is -534797

At 20% discount rate the NPV is negative (9494862 - 10029659 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Analytics Royal 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 Analytics Royal has a NPV value higher than Zero then finance managers at Analytics Royal 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 Analytics Royal, then the stock price of the Analytics Royal 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 Analytics Royal 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 can impact the cash flow of the project.

Understanding of risks involved in 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.

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.

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 Royal Bank of Canada: Using People Strategy and Analytics to Drive Employee Performance (B)

References & Further Readings

Debra Schifrin, Kathryn Shaw (2018), "Royal Bank of Canada: Using People Strategy and Analytics to Drive Employee Performance (B) Harvard Business Review Case Study. Published by HBR Publications.