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The Counter-Conventional Mindsets of Entrepreneurs 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 Counter-Conventional Mindsets of Entrepreneurs case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Counter-Conventional Mindsets of Entrepreneurs case study is a Harvard Business School (HBR) case study written by John Mullins. The The Counter-Conventional Mindsets of Entrepreneurs (referred as “Entrepreneurs Entrepreneurial” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Innovation.

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 Counter-Conventional Mindsets of Entrepreneurs Case Study


These days, it seems, nearly everyone aspires to be an entrepreneur. But many entrepreneurs think and act differently than the way in which most other businesspeople do and the way much of today's business education encourages them to think and act. My in-depth examination of dozens of entrepreneurs I've come to know well over the past 2 decades tells me that their unconventional-or, dare I say, counter-conventional-mindsets and behaviors are marked by six common patterns: (1) 'Yes, we can;' (2) beg, borrow, or steal; (3) think narrow, not broad; (4) problem-first, not product-first logic; (5) 'No' is something waiting to be turned into 'Yes'; and (6) ask for the cash and ride the float. Thankfully, we now know that entrepreneurs are made, not born. These six patterns of entrepreneurial thought and action are eminently learnable. If you want to someday be an entrepreneur, or if you want the people in your company to become more entrepreneurial, then developing-or encouraging and incentivizing your people to develop-such a mindset might constitute a suitable first step toward preparing you to follow a more entrepreneurial path or to foster a more entrepreneurial culture in your company.


Case Authors : John Mullins

Topic : Innovation & Entrepreneurship

Related Areas : Innovation




Calculating Net Present Value (NPV) at 6% for The Counter-Conventional Mindsets of Entrepreneurs Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10023642) -10023642 - -
Year 1 3454963 -6568679 3454963 0.9434 3259399
Year 2 3964591 -2604088 7419554 0.89 3528472
Year 3 3948356 1344268 11367910 0.8396 3315116
Year 4 3225092 4569360 14593002 0.7921 2554575
TOTAL 14593002 12657562


The Net Present Value at 6% discount rate is 2633920

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. 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. Entrepreneurs Entrepreneurial 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 Entrepreneurs Entrepreneurial 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 Counter-Conventional Mindsets of Entrepreneurs

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 Innovation & Entrepreneurship 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 Entrepreneurs Entrepreneurial 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 Entrepreneurs Entrepreneurial 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 (10023642) -10023642 - -
Year 1 3454963 -6568679 3454963 0.8696 3004316
Year 2 3964591 -2604088 7419554 0.7561 2997800
Year 3 3948356 1344268 11367910 0.6575 2596108
Year 4 3225092 4569360 14593002 0.5718 1843957
TOTAL 10442181


The Net NPV after 4 years is 418539

(10442181 - 10023642 )






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 (10023642) -10023642 - -
Year 1 3454963 -6568679 3454963 0.8333 2879136
Year 2 3964591 -2604088 7419554 0.6944 2753188
Year 3 3948356 1344268 11367910 0.5787 2284928
Year 4 3225092 4569360 14593002 0.4823 1555311
TOTAL 9472563


The Net NPV after 4 years is -551079

At 20% discount rate the NPV is negative (9472563 - 10023642 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Entrepreneurs Entrepreneurial 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 Entrepreneurs Entrepreneurial has a NPV value higher than Zero then finance managers at Entrepreneurs Entrepreneurial 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 Entrepreneurs Entrepreneurial, then the stock price of the Entrepreneurs Entrepreneurial 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 Entrepreneurs Entrepreneurial 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 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 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.




References & Further Readings

John Mullins (2018), "The Counter-Conventional Mindsets of Entrepreneurs Harvard Business Review Case Study. Published by HBR Publications.