Talking Strategy at Greighton Partners 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 Talking Strategy at Greighton Partners case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Talking Strategy at Greighton Partners case study is a Harvard Business School (HBR) case study written by Boris Groysberg, Kerry Herman. The Talking Strategy at Greighton Partners (referred as “Greighton Firm” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Financial management, Growth strategy, Managing people, 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 Talking Strategy at Greighton Partners Case Study

Since its inception, London-based private equity firm Greighton Partners had managed over $15 billion in investor capital. The firm employed about 150 professionals around the globe and had completed over 175 company acquisitions since its founding. Started with a small intimate team in London, the firm had merged with a continental PE firm and was successful, with an increased focus on Asia deals. After a long day of global partner meetings behind them, a group of Greighton partners, eager to unwind, gathered to discuss the firm's success in terms of executing on its recently refined strategy. Opinions ranged across the following strategic issues: growing the firm's Asian footprint versus remaining focused in Europe; aiming to be a top performing mid-market firm or focusing on moving up a tier to compete for bigger deals against larger firms; growth and expansion through organic growth, merger/acquisition, or through lateral hires; and finally, sector mix and client mix/client focus.

Case Authors : Boris Groysberg, Kerry Herman

Topic : Finance & Accounting

Related Areas : Financial management, Growth strategy, Managing people, Organizational culture

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Calculating Net Present Value (NPV) at 6% for Talking Strategy at Greighton Partners Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019284)	-10019284	-	-
Year 1	3445487	-6573797	3445487	0.9434	3250459
Year 2	3973588	-2600209	7419075	0.89	3536479
Year 3	3954770	1354561	11373845	0.8396	3320501
Year 4	3234131	4588692	14607976	0.7921	2561735
TOTAL			14607976		12669174

The Net Present Value at 6% discount rate is 2649890

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. Payback Period
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. Greighton Firm 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 Greighton Firm 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 Talking Strategy at Greighton Partners

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 Finance & Accounting 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 Greighton Firm 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 Greighton Firm 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	(10019284)	-10019284	-	-
Year 1	3445487	-6573797	3445487	0.8696	2996076
Year 2	3973588	-2600209	7419075	0.7561	3004603
Year 3	3954770	1354561	11373845	0.6575	2600325
Year 4	3234131	4588692	14607976	0.5718	1849125
TOTAL					10450129

The Net NPV after 4 years is 430845

(10450129 - 10019284 )

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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	(10019284)	-10019284	-	-
Year 1	3445487	-6573797	3445487	0.8333	2871239
Year 2	3973588	-2600209	7419075	0.6944	2759436
Year 3	3954770	1354561	11373845	0.5787	2288640
Year 4	3234131	4588692	14607976	0.4823	1559670
TOTAL					9478985

The Net NPV after 4 years is -540299

At 20% discount rate the NPV is negative (9478985 - 10019284 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Greighton Firm 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 Greighton Firm has a NPV value higher than Zero then finance managers at Greighton Firm 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 Greighton Firm, then the stock price of the Greighton Firm 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 Greighton Firm 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 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 can impact the cash flow of 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 Talking Strategy at Greighton Partners

References & Further Readings

Boris Groysberg, Kerry Herman (2018), "Talking Strategy at Greighton Partners Harvard Business Review Case Study. Published by HBR Publications.