Leadership Under High Pressure 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 Leadership Under High Pressure case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Leadership Under High Pressure case study is a Harvard Business School (HBR) case study written by Jan Hagen. The Leadership Under High Pressure (referred as “Unfamiliar Participant” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Crisis management, Decision making, Government, Leadership, Leading teams.

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 Leadership Under High Pressure Case Study

When managers are confronted with a corporate crisis, they have to operate under conditions that differ fundamentally from those experienced during normal management processes. They may have to work with specialized teams and understand their priorities and decision making processes, without giving up their own responsibilities. The following case simulation confronts participants with an escalating crisis situation in an unfamiliar environment and requires a series of team decisions to be taken under time pressure. The case is based on real experiences of the German Air Force during its ISAF mission in Afghanistan. The participants are divided into groups of four, each group being responsible for a large military transport aircraft and its mission. Within the groups, each participant assumes the role of a specified flight crew member. Each participant receives individual instructions on their roles and duties as well as background information on the other crew members. Based on this information, the teams must prepare and execute their flight missions. The main objective of the simulation is to highlight the challenges of sharing information within a team and of decision making under time pressure in an unfamiliar environment.

Case Authors : Jan Hagen

Topic : Leadership & Managing People

Related Areas : Crisis management, Decision making, Government, Leadership, Leading teams

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Calculating Net Present Value (NPV) at 6% for Leadership Under High Pressure Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10002936)	-10002936	-	-
Year 1	3451270	-6551666	3451270	0.9434	3255915
Year 2	3973270	-2578396	7424540	0.89	3536196
Year 3	3946179	1367783	11370719	0.8396	3313288
Year 4	3247907	4615690	14618626	0.7921	2572647
TOTAL			14618626		12678046

The Net Present Value at 6% discount rate is 2675110

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. Internal Rate of Return
2. Profitability Index
3. Net Present Value
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. Unfamiliar Participant 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 Unfamiliar Participant 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 Leadership Under High Pressure

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 Leadership & Managing People 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 Unfamiliar Participant 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 Unfamiliar Participant 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	(10002936)	-10002936	-	-
Year 1	3451270	-6551666	3451270	0.8696	3001104
Year 2	3973270	-2578396	7424540	0.7561	3004363
Year 3	3946179	1367783	11370719	0.6575	2594677
Year 4	3247907	4615690	14618626	0.5718	1857001
TOTAL					10457145

The Net NPV after 4 years is 454209

(10457145 - 10002936 )

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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	(10002936)	-10002936	-	-
Year 1	3451270	-6551666	3451270	0.8333	2876058
Year 2	3973270	-2578396	7424540	0.6944	2759215
Year 3	3946179	1367783	11370719	0.5787	2283668
Year 4	3247907	4615690	14618626	0.4823	1566313
TOTAL					9485255

The Net NPV after 4 years is -517681

At 20% discount rate the NPV is negative (9485255 - 10002936 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Unfamiliar Participant 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 Unfamiliar Participant has a NPV value higher than Zero then finance managers at Unfamiliar Participant 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 Unfamiliar Participant, then the stock price of the Unfamiliar Participant 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 Unfamiliar Participant 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 can impact the cash flow of the project.

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.

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 Leadership Under High Pressure

References & Further Readings

Jan Hagen (2018), "Leadership Under High Pressure Harvard Business Review Case Study. Published by HBR Publications.