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In the Crossfire: Guns, Legislative Leadership and Recall Politics in Colorado 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 In the Crossfire: Guns, Legislative Leadership and Recall Politics in Colorado case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. In the Crossfire: Guns, Legislative Leadership and Recall Politics in Colorado case study is a Harvard Business School (HBR) case study written by David King, Laura Winig. The In the Crossfire: Guns, Legislative Leadership and Recall Politics in Colorado (referred as “Recall Morse” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Risk management.

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 In the Crossfire: Guns, Legislative Leadership and Recall Politics in Colorado Case Study


In 2013, democratic Colorado state senators John Morse and Angela Giron were recalled from office in the wake of a successful recall campaign launched by grassroots groups angered by the senators' support for newly-enacted gun control legislation. After Morse and Giron were recalled, Democrats retained a one-seat majority in the Senate. Some critics thought Morse should have anticipated the recall election result and resigned while others expressed concern that Morse's ouster had legitimized the use of recall politics-typically used to unseat politicians over ethical issues-as a way for voters to punish supporters of controversial issues. The case asks students to consider the benefits and drawbacks of recall elections and how they can be used by political activists and interest groups as a tool to manage political representation.


Case Authors : David King, Laura Winig

Topic : Global Business

Related Areas : Risk management




Calculating Net Present Value (NPV) at 6% for In the Crossfire: Guns, Legislative Leadership and Recall Politics in Colorado Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10024915) -10024915 - -
Year 1 3461264 -6563651 3461264 0.9434 3265343
Year 2 3976059 -2587592 7437323 0.89 3538678
Year 3 3949647 1362055 11386970 0.8396 3316200
Year 4 3244796 4606851 14631766 0.7921 2570182
TOTAL 14631766 12690404




The Net Present Value at 6% discount rate is 2665489

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. Recall Morse 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 Recall Morse 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 In the Crossfire: Guns, Legislative Leadership and Recall Politics in Colorado

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 Global Business 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 Recall Morse 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 Recall Morse 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 (10024915) -10024915 - -
Year 1 3461264 -6563651 3461264 0.8696 3009795
Year 2 3976059 -2587592 7437323 0.7561 3006472
Year 3 3949647 1362055 11386970 0.6575 2596957
Year 4 3244796 4606851 14631766 0.5718 1855223
TOTAL 10468446


The Net NPV after 4 years is 443531

(10468446 - 10024915 )








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 (10024915) -10024915 - -
Year 1 3461264 -6563651 3461264 0.8333 2884387
Year 2 3976059 -2587592 7437323 0.6944 2761152
Year 3 3949647 1362055 11386970 0.5787 2285675
Year 4 3244796 4606851 14631766 0.4823 1564813
TOTAL 9496027


The Net NPV after 4 years is -528888

At 20% discount rate the NPV is negative (9496027 - 10024915 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Recall Morse 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 Recall Morse has a NPV value higher than Zero then finance managers at Recall Morse 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 Recall Morse, then the stock price of the Recall Morse 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 Recall Morse 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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.

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.






Negotiation Strategy of In the Crossfire: Guns, Legislative Leadership and Recall Politics in Colorado

References & Further Readings

David King, Laura Winig (2018), "In the Crossfire: Guns, Legislative Leadership and Recall Politics in Colorado Harvard Business Review Case Study. Published by HBR Publications.


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