Student Guide to the Case Method: Note 3 - Preparing to Discuss a Case 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 Student Guide to the Case Method: Note 3 - Preparing to Discuss a Case case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Student Guide to the Case Method: Note 3 - Preparing to Discuss a Case case study is a Harvard Business School (HBR) case study written by Susan J. Van Weelden, Laurie George Busuttil. The Student Guide to the Case Method: Note 3 - Preparing to Discuss a Case (referred as “Method Students” from here on) case study provides evaluation & decision scenario in field of Communication. It also touches upon business topics such as - Value proposition, Presentations, 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

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Case Description of Student Guide to the Case Method: Note 3 - Preparing to Discuss a Case Case Study

Case analysis is an effective tool for teaching, learning, and most importantly, practising the art and science of management. The case method immerses students in real-life situations, allowing them to develop their business skills by analyzing realistic situations, applying business theories and tools, and making substantiated recommendations for a course of action. However, working with cases is a pedagogical approach that is unfamiliar to most new business students and often inadequately understood by advanced students. The Case Guide Series introduces students to the case method and, in discrete notes, walks them through the tasks that are typically involved in case assignments: analyzing a case, discussing cases in class, writing case reports and giving presentations (individually and in groups), and writing case exams. A final note introduces students to the most common business tools used for case analysis. This field-tested series is best used as a complete package to orient students to the case method, but each note also stands on its own and can be used to supplement other course materials. Preparing to Discuss a Case: Discussion of cases can be used either to apply and supplement lecture material or as the main pedagogical tool. To benefit from discussion and to provide meaningful input, students need to take time to adequately prepare. Note 3 of the Case Guide Series provides students with an approach for preparing for class and participating effectively and with diplomacy in class discussions. Susan J. Van Weelden and Laurie George Busuttil are affiliated with Redeemer University College.

Case Authors : Susan J. Van Weelden, Laurie George Busuttil

Topic : Communication

Related Areas : Presentations, Strategic planning

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Calculating Net Present Value (NPV) at 6% for Student Guide to the Case Method: Note 3 - Preparing to Discuss a Case Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10007086)	-10007086	-	-
Year 1	3443347	-6563739	3443347	0.9434	3248441
Year 2	3978432	-2585307	7421779	0.89	3540790
Year 3	3946938	1361631	11368717	0.8396	3313925
Year 4	3238405	4600036	14607122	0.7921	2565120
TOTAL			14607122		12668276

The Net Present Value at 6% discount rate is 2661190

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. Profitability Index
2. Payback Period
3. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Method Students 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 Method Students 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 Student Guide to the Case Method: Note 3 - Preparing to Discuss a Case

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 Communication 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 Method Students 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 Method Students 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	(10007086)	-10007086	-	-
Year 1	3443347	-6563739	3443347	0.8696	2994215
Year 2	3978432	-2585307	7421779	0.7561	3008266
Year 3	3946938	1361631	11368717	0.6575	2595176
Year 4	3238405	4600036	14607122	0.5718	1851569
TOTAL					10449225

The Net NPV after 4 years is 442139

(10449225 - 10007086 )

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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	(10007086)	-10007086	-	-
Year 1	3443347	-6563739	3443347	0.8333	2869456
Year 2	3978432	-2585307	7421779	0.6944	2762800
Year 3	3946938	1361631	11368717	0.5787	2284108
Year 4	3238405	4600036	14607122	0.4823	1561731
TOTAL					9478094

The Net NPV after 4 years is -528992

At 20% discount rate the NPV is negative (9478094 - 10007086 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Method Students 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 Method Students has a NPV value higher than Zero then finance managers at Method Students 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 Method Students, then the stock price of the Method Students 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 Method Students 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 key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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.

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Negotiation Strategy of Student Guide to the Case Method: Note 3 - Preparing to Discuss a Case

References & Further Readings

Susan J. Van Weelden, Laurie George Busuttil (2018), "Student Guide to the Case Method: Note 3 - Preparing to Discuss a Case Harvard Business Review Case Study. Published by HBR Publications.