DTE Energy (A): Becoming a Transformational Leader: Gerry Anderson, Chairman and CEO 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 DTE Energy (A): Becoming a Transformational Leader: Gerry Anderson, Chairman and CEO case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. DTE Energy (A): Becoming a Transformational Leader: Gerry Anderson, Chairman and CEO case study is a Harvard Business School (HBR) case study written by Robert Quinn. The DTE Energy (A): Becoming a Transformational Leader: Gerry Anderson, Chairman and CEO (referred as “Dte Anderson” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Leadership, Organizational culture.

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 DTE Energy (A): Becoming a Transformational Leader: Gerry Anderson, Chairman and CEO Case Study

This case describes DTE Energy CEO Gerry Anderson's transformation from a hard-nosed, "old school" leader to an authentic, purpose-driven leader implementing positive change. Students follow along as Anderson begins re-thinking his approach to leadership from a cost-focus to a more holistic view that employees are not "simply factors of production" and that management by edict was not sustainable. But just as Anderson is slowly earning employees' trust, the recession of 2008 hits and DTE faces a potential loss of $175 million. Anderson is confronted with the biggest challenge of his career: should he lay off a large portion of the workforce to save the company? Such a move would undermine all he had been working toward in his new leadership style and would destroy the trust he had been trying to build in the company, but his management team sees no alternative. What should Anderson do? This is Case A of a three-case series which can be taught sequentially or as stand-alone cases. The cases describe the organizational transformation of energy utility company DTE Energy into a positive organization, focusing first on the personal transformation of DTE's CEO, Gerry Anderson (Case A); then on the transformation of the company (Case B) and finally on DTE Energy's advancement to the "next level" - positive social issues to improve the wider community and societal context in which the company operates (Case C).

Case Authors : Robert Quinn

Topic : Organizational Development

Related Areas : Leadership, Organizational culture

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Calculating Net Present Value (NPV) at 6% for DTE Energy (A): Becoming a Transformational Leader: Gerry Anderson, Chairman and CEO Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019888)	-10019888	-	-
Year 1	3463848	-6556040	3463848	0.9434	3267781
Year 2	3967611	-2588429	7431459	0.89	3531160
Year 3	3936419	1347990	11367878	0.8396	3305093
Year 4	3244857	4592847	14612735	0.7921	2570231
TOTAL			14612735		12674265

The Net Present Value at 6% discount rate is 2654377

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. Profitability Index
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. Timing of the expected cash flows – stockholders of Dte Anderson 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. Dte Anderson 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 DTE Energy (A): Becoming a Transformational Leader: Gerry Anderson, Chairman and CEO

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 Dte Anderson 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 Dte Anderson 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	(10019888)	-10019888	-	-
Year 1	3463848	-6556040	3463848	0.8696	3012042
Year 2	3967611	-2588429	7431459	0.7561	3000084
Year 3	3936419	1347990	11367878	0.6575	2588259
Year 4	3244857	4592847	14612735	0.5718	1855258
TOTAL					10455643

The Net NPV after 4 years is 435755

(10455643 - 10019888 )

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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	(10019888)	-10019888	-	-
Year 1	3463848	-6556040	3463848	0.8333	2886540
Year 2	3967611	-2588429	7431459	0.6944	2755285
Year 3	3936419	1347990	11367878	0.5787	2278020
Year 4	3244857	4592847	14612735	0.4823	1564842
TOTAL					9484688

The Net NPV after 4 years is -535200

At 20% discount rate the NPV is negative (9484688 - 10019888 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Dte Anderson 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 Dte Anderson has a NPV value higher than Zero then finance managers at Dte Anderson 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 Dte Anderson, then the stock price of the Dte Anderson 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 Dte Anderson 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.

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.

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.

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 DTE Energy (A): Becoming a Transformational Leader: Gerry Anderson, Chairman and CEO

References & Further Readings

Robert Quinn (2018), "DTE Energy (A): Becoming a Transformational Leader: Gerry Anderson, Chairman and CEO Harvard Business Review Case Study. Published by HBR Publications.