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Making the Most of the Chicago Benchmarking Collaborative 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 Making the Most of the Chicago Benchmarking Collaborative case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Making the Most of the Chicago Benchmarking Collaborative case study is a Harvard Business School (HBR) case study written by Liz Livingston Howard, Michelle Shumate. The Making the Most of the Chicago Benchmarking Collaborative (referred as “Cbc Chicago” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, IT, Joint ventures, Organizational culture, Performance measurement, Strategic planning.

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 Making the Most of the Chicago Benchmarking Collaborative Case Study


In this case, lessons from the Chicago Benchmarking Collaborative illustrate key principles of collaborative action and the importance of using data to achieve SMART goals. In 2015, the Chicago Benchmarking Collaborative (CBC) was a network of seven agencies in Chicago, Illinois, serving 12,000 low-income residents. Each of the agencies had early childhood, school-age children, and adult education programs. At the prompting of the Chicago Community Trust, they came together to (1) benchmark their education programs outputs and outcomes; (2) learn and share best practices through developing a common set of metrics and measurements and implementing these measurements into a case management software system; and (3) share the costs of the case management software system to be used for program evaluation and continuous quality improvement. Three aspects of CBC are particularly noteworthy. First, there are no joint program activities or clients among these agencies. Their exchange is limited to sharing data and other information. This makes CBC distinct from collaborations formed to begin a program or to advocate for a policy. Second, the group requires each agency to enter data on a timely basis and to set SMART goals based on the data reports. The agencies are held mutually accountable for their work to achieve their own SMART goals during the year and report on progress. Third, CBC used monetary incentives to ensure that data entry and SMART goal action remained a priority for each agency.


Case Authors : Liz Livingston Howard, Michelle Shumate

Topic : Innovation & Entrepreneurship

Related Areas : IT, Joint ventures, Organizational culture, Performance measurement, Strategic planning




Calculating Net Present Value (NPV) at 6% for Making the Most of the Chicago Benchmarking Collaborative Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10028474) -10028474 - -
Year 1 3468355 -6560119 3468355 0.9434 3272033
Year 2 3975967 -2584152 7444322 0.89 3538596
Year 3 3938025 1353873 11382347 0.8396 3306442
Year 4 3241201 4595074 14623548 0.7921 2567335
TOTAL 14623548 12684406


The Net Present Value at 6% discount rate is 2655932

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. 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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Cbc Chicago 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 Cbc Chicago 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 Making the Most of the Chicago Benchmarking Collaborative

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 Cbc Chicago 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 Cbc Chicago 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 (10028474) -10028474 - -
Year 1 3468355 -6560119 3468355 0.8696 3015961
Year 2 3975967 -2584152 7444322 0.7561 3006402
Year 3 3938025 1353873 11382347 0.6575 2589315
Year 4 3241201 4595074 14623548 0.5718 1853167
TOTAL 10464846


The Net NPV after 4 years is 436372

(10464846 - 10028474 )






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 (10028474) -10028474 - -
Year 1 3468355 -6560119 3468355 0.8333 2890296
Year 2 3975967 -2584152 7444322 0.6944 2761088
Year 3 3938025 1353873 11382347 0.5787 2278950
Year 4 3241201 4595074 14623548 0.4823 1563079
TOTAL 9493413


The Net NPV after 4 years is -535061

At 20% discount rate the NPV is negative (9493413 - 10028474 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Cbc Chicago 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 Cbc Chicago has a NPV value higher than Zero then finance managers at Cbc Chicago 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 Cbc Chicago, then the stock price of the Cbc Chicago 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 Cbc Chicago 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 key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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.

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

Liz Livingston Howard, Michelle Shumate (2018), "Making the Most of the Chicago Benchmarking Collaborative Harvard Business Review Case Study. Published by HBR Publications.