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AT&T: Managing Technological Change and the Future of Telephone Operators in the 20th Century 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 AT&T: Managing Technological Change and the Future of Telephone Operators in the 20th Century case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. AT&T: Managing Technological Change and the Future of Telephone Operators in the 20th Century case study is a Harvard Business School (HBR) case study written by Daniel P. Gross, William R. Kerr. The AT&T: Managing Technological Change and the Future of Telephone Operators in the 20th Century (referred as “Operators 1930s” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Change management, Communication, Disruptive innovation, Strategy, Technology.

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 AT&T: Managing Technological Change and the Future of Telephone Operators in the 20th Century Case Study


By the 1930s, AT&T dominated the American phone industry, serving 10 million telephones and employing over 100,000 switchboard operators. But beginning in the mid-1910s, the company began changing from manually-operated switchboards to mechanical switching systems that were faster and more cost-effective and did not require human operators. By the 1930s, the changeover has been completed or is underway in most American cities with over 50,000 people. The rollout of the new technology is garnering a good deal of public attention, not just for the unfamiliar new "dialing" process that customers are required to learn, but also because of the mass layoffs of the women who served as operators. The job cuts have even resulted in reports from the Department of Labor and Congressional hearings. As the rollouts continue across the country, AT&T questions how to handle the layoffs and the reaction to the new system.


Case Authors : Daniel P. Gross, William R. Kerr

Topic : Strategy & Execution

Related Areas : Change management, Communication, Disruptive innovation, Strategy, Technology




Calculating Net Present Value (NPV) at 6% for AT&T: Managing Technological Change and the Future of Telephone Operators in the 20th Century Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10029118) -10029118 - -
Year 1 3444970 -6584148 3444970 0.9434 3249972
Year 2 3971036 -2613112 7416006 0.89 3534208
Year 3 3937870 1324758 11353876 0.8396 3306312
Year 4 3236144 4560902 14590020 0.7921 2563329
TOTAL 14590020 12653820


The Net Present Value at 6% discount rate is 2624702

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. Internal Rate of Return
3. Profitability Index
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. Operators 1930s 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 Operators 1930s 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 AT&T: Managing Technological Change and the Future of Telephone Operators in the 20th Century

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 Strategy & Execution 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 Operators 1930s 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 Operators 1930s 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 (10029118) -10029118 - -
Year 1 3444970 -6584148 3444970 0.8696 2995626
Year 2 3971036 -2613112 7416006 0.7561 3002674
Year 3 3937870 1324758 11353876 0.6575 2589213
Year 4 3236144 4560902 14590020 0.5718 1850276
TOTAL 10437789


The Net NPV after 4 years is 408671

(10437789 - 10029118 )






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 (10029118) -10029118 - -
Year 1 3444970 -6584148 3444970 0.8333 2870808
Year 2 3971036 -2613112 7416006 0.6944 2757664
Year 3 3937870 1324758 11353876 0.5787 2278860
Year 4 3236144 4560902 14590020 0.4823 1560640
TOTAL 9467973


The Net NPV after 4 years is -561145

At 20% discount rate the NPV is negative (9467973 - 10029118 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Operators 1930s 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 Operators 1930s has a NPV value higher than Zero then finance managers at Operators 1930s 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 Operators 1930s, then the stock price of the Operators 1930s 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 Operators 1930s 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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

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 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.




References & Further Readings

Daniel P. Gross, William R. Kerr (2018), "AT&T: Managing Technological Change and the Future of Telephone Operators in the 20th Century Harvard Business Review Case Study. Published by HBR Publications.