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The Panic of 1837 and the Market Revolution in America (A) 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 The Panic of 1837 and the Market Revolution in America (A) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Panic of 1837 and the Market Revolution in America (A) case study is a Harvard Business School (HBR) case study written by Robert F. Bruner. The The Panic of 1837 and the Market Revolution in America (A) (referred as “1837 Panic” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Financial management, Recession.

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 The Panic of 1837 and the Market Revolution in America (A) Case Study


In 1837, President Martin Van Buren confronted a dilemma over the appropriate federal response to the recent panic of 1837 that seemed to undercut the policies and power of Andrew Jackson's "Democracy." Now, Van Buren must decide how best to harness the civic reaction in stabilizing the financial system and returning the American economy to growth. Van Buren's dilemma occurs in the midst of a dramatic regime shift in American politics. The rise of Whig politicians in reaction to the populist policies of Andrew Jackson marked 1837 as an historic pivot-point. It is useful to consider how the panic of 1837 contributed to that pivot and how the subsequent civic reaction to the panic developed. The A case recounts the policies of President Andrew Jackson and his "war" on the Second Bank of the United States, a quasi-central bank. It also describes the "market revolution" occurring in the U.S. economy and the political factions that had emerged. Finally, it summarizes the causes and story of the panic of 1837. The B case presents draft legislation for an Independent Treasury and President Van Buren's message with which he aimed to open a special session of the U.S. Congress and enact the Independent Treasury proposal. The C case describes the failures to enact the proposal in 1837, 1838, and 1839-ultimately the proposal was enacted in 1840. The case also describes other civic reactions: a new Bankruptcy Act and state-level "free banking" laws. Finally, the case describes the economic aftermath: another panic in 1839 and a long depression that ensued.


Case Authors : Robert F. Bruner

Topic : Finance & Accounting

Related Areas : Financial management, Recession




Calculating Net Present Value (NPV) at 6% for The Panic of 1837 and the Market Revolution in America (A) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10022475) -10022475 - -
Year 1 3451997 -6570478 3451997 0.9434 3256601
Year 2 3978681 -2591797 7430678 0.89 3541012
Year 3 3944008 1352211 11374686 0.8396 3311465
Year 4 3235190 4587401 14609876 0.7921 2562573
TOTAL 14609876 12671652


The Net Present Value at 6% discount rate is 2649177

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. Payback Period
2. Profitability Index
3. Internal Rate of Return
4. Net Present Value

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. 1837 Panic 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 1837 Panic 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 The Panic of 1837 and the Market Revolution in America (A)

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 Finance & Accounting 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 1837 Panic 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 1837 Panic 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 (10022475) -10022475 - -
Year 1 3451997 -6570478 3451997 0.8696 3001737
Year 2 3978681 -2591797 7430678 0.7561 3008454
Year 3 3944008 1352211 11374686 0.6575 2593249
Year 4 3235190 4587401 14609876 0.5718 1849730
TOTAL 10453171


The Net NPV after 4 years is 430696

(10453171 - 10022475 )






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 (10022475) -10022475 - -
Year 1 3451997 -6570478 3451997 0.8333 2876664
Year 2 3978681 -2591797 7430678 0.6944 2762973
Year 3 3944008 1352211 11374686 0.5787 2282412
Year 4 3235190 4587401 14609876 0.4823 1560180
TOTAL 9482229


The Net NPV after 4 years is -540246

At 20% discount rate the NPV is negative (9482229 - 10022475 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of 1837 Panic 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 1837 Panic has a NPV value higher than Zero then finance managers at 1837 Panic 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 1837 Panic, then the stock price of the 1837 Panic 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 1837 Panic 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 can impact the cash flow of 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.

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.




References & Further Readings

Robert F. Bruner (2018), "The Panic of 1837 and the Market Revolution in America (A) Harvard Business Review Case Study. Published by HBR Publications.