A New Approach to Designing Work 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 A New Approach to Designing Work case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. A New Approach to Designing Work case study is a Harvard Business School (HBR) case study written by Nelson P. Repenning, Don Kieffer, James Repenning. The A New Approach to Designing Work (referred as “Design Serial” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Organizational structure.

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 A New Approach to Designing Work Case Study

This is an MIT Sloan Management Review article. The goal of this article, according to the authors, is to help managers understand several key work design principles that undergird not only agile practices in software but also Toyota Motor Corp.'s well-known production system. Understanding these underlying work design principles -through a framework the authors call dynamic work design -enables managers to create work processes in their own organizations that are both more flexible and more efficient. Traditionally, an academic theory known as contingency theory has suggested that if work consists of well-defined tasks (for example, assembling components), then it is best to organize it serially, like a factory assembly line. Conversely, if work is highly ambiguous and requires ongoing interaction (for example, designing new products), then it is best organized collaboratively. The authors argue that this approach to work design is not entirely satisfying for two reasons. First, it describes an unpalatable trade-off: Work done using a serial factory design isn't very flexible, making it hard to adapt to changes in external conditions, and work done using the collaborative approach often isn't very efficient. Second, few types of work perfectly fit the archetype of well-defined or ambiguous work. The authors instead advocate a dynamic approach to process and organizational design that transcends the serial versus collaborative work framework by creating mechanisms for moving between the two basic ways of organizing work at appropriate intervals. By identifying mechanisms to cycle back and forth between well-defined factory-style tasks and collaborative modes when appropriate, managers can considerably reduce the trade-off between efficiency and adaptability. For example, work on Toyota assembly lines is the epitome of the serial, mechanistic work design, and tasks are precisely specified. But sometimes things go awry. In the Toyota scheme, a worker noticing such an issue is supposed to pull the Andon cord (or push a button) to stop the production line and fix the problem, which temporarily changes the work design to a collaborative problem-solving mode. Once the problem is resolved, the operator returns to the serial work design. The authors argue that movement between the two work modes is also the key to understanding the success of agile software development methods.

Case Authors : Nelson P. Repenning, Don Kieffer, James Repenning

Topic : Organizational Development

Related Areas : Organizational structure

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Calculating Net Present Value (NPV) at 6% for A New Approach to Designing Work Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10010480)	-10010480	-	-
Year 1	3452659	-6557821	3452659	0.9434	3257225
Year 2	3969679	-2588142	7422338	0.89	3533000
Year 3	3964985	1376843	11387323	0.8396	3329078
Year 4	3231916	4608759	14619239	0.7921	2559980
TOTAL			14619239		12679284

The Net Present Value at 6% discount rate is 2668804

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

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. Timing of the expected cash flows – stockholders of Design Serial have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Design Serial shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of A New Approach to Designing Work

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 Organizational Development 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 Design Serial 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 Design Serial 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	(10010480)	-10010480	-	-
Year 1	3452659	-6557821	3452659	0.8696	3002312
Year 2	3969679	-2588142	7422338	0.7561	3001648
Year 3	3964985	1376843	11387323	0.6575	2607042
Year 4	3231916	4608759	14619239	0.5718	1847858
TOTAL					10458860

The Net NPV after 4 years is 448380

(10458860 - 10010480 )

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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	(10010480)	-10010480	-	-
Year 1	3452659	-6557821	3452659	0.8333	2877216
Year 2	3969679	-2588142	7422338	0.6944	2756722
Year 3	3964985	1376843	11387323	0.5787	2294552
Year 4	3231916	4608759	14619239	0.4823	1558601
TOTAL					9487090

The Net NPV after 4 years is -523390

At 20% discount rate the NPV is negative (9487090 - 10010480 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Design Serial 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 Design Serial has a NPV value higher than Zero then finance managers at Design Serial 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 Design Serial, then the stock price of the Design Serial 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 Design Serial 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 –

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.

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 A New Approach to Designing Work

References & Further Readings

Nelson P. Repenning, Don Kieffer, James Repenning (2018), "A New Approach to Designing Work Harvard Business Review Case Study. Published by HBR Publications.