Why Design Thinking in Business Needs a Rethink 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 Why Design Thinking in Business Needs a Rethink case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Why Design Thinking in Business Needs a Rethink case study is a Harvard Business School (HBR) case study written by Martin Kupp, Jamie Anderson, Jorg Reckhenrich. The Why Design Thinking in Business Needs a Rethink (referred as “Thinking Design” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, .

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 Why Design Thinking in Business Needs a Rethink Case Study

In recent years, "design thinking"has become popular in many industries as established companies have tried to apply designers'problem-solving techniques to corporate innovation processes. Key elements of the design thinking methodology include fast iterations; early and frequent interaction with customers; agile process design with less hierarchy; and a learning-by-doing approach that involves building prototypes and creating mock-ups of any kind as early as possible in the process. Over the past seven years, the authors have helped more than 20 companies pursue more than 50 design thinking initiatives and have found that such initiatives rarely proceed according to the textbook model. Innovation, they note, is an inherently messy process that conflicts in many ways with established companies'processes, structures, and corporate cultures. For example, they note, many established companies punish failure, which discourages the risk-taking design thinking requires. What's more, the design thinking methodology calls for egalitarian, self-organized teams, but this isn't how most large companies work. In fact, the design thinking teams the authors studied tended to have clear process and project owners, usually senior managers who often supervised 12 to 15 design thinking projects at a time. The authors argue that companies need to take five steps to take full advantage of the potential of design thinking. They recommend that companies (1) encourage top managers to champion design thinking initiatives, (2) balance intuitive and analytical thinking on design thinking teams, (3) set ground rules that give design thinking teams the autonomy they need to function well, (4) integrate design thinking into the company's product development processes, and (5) focus on learning rather than on profits as metrics for design thinking projects. "To be successful, a design thinking program must be closely linked with the organization's social dynamics,"the authors write. "Without the right supporting mechanisms, you probably won't achieve the desired results."

Case Authors : Martin Kupp, Jamie Anderson, Jorg Reckhenrich

Topic : Strategy & Execution

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Why Design Thinking in Business Needs a Rethink Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10020443)	-10020443	-	-
Year 1	3466198	-6554245	3466198	0.9434	3269998
Year 2	3954249	-2599996	7420447	0.89	3519268
Year 3	3949182	1349186	11369629	0.8396	3315809
Year 4	3227839	4577025	14597468	0.7921	2556751
TOTAL			14597468		12661826

The Net Present Value at 6% discount rate is 2641383

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. Payback Period
3. Profitability Index
4. Internal Rate of Return

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. Thinking Design 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 Thinking Design 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 Why Design Thinking in Business Needs a Rethink

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 Strategy & Execution 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 Thinking Design 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 Thinking Design 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	(10020443)	-10020443	-	-
Year 1	3466198	-6554245	3466198	0.8696	3014085
Year 2	3954249	-2599996	7420447	0.7561	2989980
Year 3	3949182	1349186	11369629	0.6575	2596651
Year 4	3227839	4577025	14597468	0.5718	1845527
TOTAL					10446244

The Net NPV after 4 years is 425801

(10446244 - 10020443 )

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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	(10020443)	-10020443	-	-
Year 1	3466198	-6554245	3466198	0.8333	2888498
Year 2	3954249	-2599996	7420447	0.6944	2746006
Year 3	3949182	1349186	11369629	0.5787	2285406
Year 4	3227839	4577025	14597468	0.4823	1556635
TOTAL					9476546

The Net NPV after 4 years is -543897

At 20% discount rate the NPV is negative (9476546 - 10020443 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Thinking Design 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 Thinking Design has a NPV value higher than Zero then finance managers at Thinking Design 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 Thinking Design, then the stock price of the Thinking Design 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 Thinking Design 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 will be a multi year spillover effect of various taxation regulations.

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.

Understanding of risks involved in the project.

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.

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Negotiation Strategy of Why Design Thinking in Business Needs a Rethink

References & Further Readings

Martin Kupp, Jamie Anderson, Jorg Reckhenrich (2018), "Why Design Thinking in Business Needs a Rethink Harvard Business Review Case Study. Published by HBR Publications.