Rock Health 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 Rock Health case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Rock Health case study is a Harvard Business School (HBR) case study written by Robert F. Higgins, Ian McKown Cornell. The Rock Health (referred as “Rock Hbs” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Health, Innovation, 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

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Case Description of Rock Health Case Study

Rock Health was a San Francisco-based nonprofit organization offering accelerator services to spur innovation at the intersection of healthcare and technology. The company was the creation of Halle Tecco (HBS '11) and her HBS classmate Nate Gross (HBS '11), who met early in their first year at the HBS Healthcare Club meeting and decided to undertake a year-long field study that married their shared interests in healthcare, technology and entrepreneurship. Rock Health supported health-tech entrepreneurs with a startup grant of $20,000, office space and a wide variety of professional support services. Entrepreneurial teams that participated in Rock Health's programs promoted services ranging from data-driven technologies that helped manage stress to mobile tools that attempted to diagnosis medical conditions as diverse as Alzheimer's disease and foot ulcers. The case is set in August 2011, as Rock Health is wrapping up its third group of entrepreneurs in a Boston program and planning for its fourth class at the home office. The case should enable students to identify emerging challenges, evaluate Rock Health's funding model, debate the effectiveness of its incubation service and assess its long-term viability.

Case Authors : Robert F. Higgins, Ian McKown Cornell

Topic : Innovation & Entrepreneurship

Related Areas : Health, Innovation, Technology

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Calculating Net Present Value (NPV) at 6% for Rock Health Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10008364)	-10008364	-	-
Year 1	3455689	-6552675	3455689	0.9434	3260084
Year 2	3954676	-2597999	7410365	0.89	3519648
Year 3	3965743	1367744	11376108	0.8396	3329714
Year 4	3232739	4600483	14608847	0.7921	2560632
TOTAL			14608847		12670078

The Net Present Value at 6% discount rate is 2661714

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. Payback Period
2. Profitability Index
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. Timing of the expected cash flows – stockholders of Rock Hbs have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Rock Hbs shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Rock Health

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 Rock Hbs 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 Rock Hbs 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	(10008364)	-10008364	-	-
Year 1	3455689	-6552675	3455689	0.8696	3004947
Year 2	3954676	-2597999	7410365	0.7561	2990303
Year 3	3965743	1367744	11376108	0.6575	2607540
Year 4	3232739	4600483	14608847	0.5718	1848329
TOTAL					10451120

The Net NPV after 4 years is 442756

(10451120 - 10008364 )

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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	(10008364)	-10008364	-	-
Year 1	3455689	-6552675	3455689	0.8333	2879741
Year 2	3954676	-2597999	7410365	0.6944	2746303
Year 3	3965743	1367744	11376108	0.5787	2294990
Year 4	3232739	4600483	14608847	0.4823	1558998
TOTAL					9480032

The Net NPV after 4 years is -528332

At 20% discount rate the NPV is negative (9480032 - 10008364 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Rock Hbs 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 Rock Hbs has a NPV value higher than Zero then finance managers at Rock Hbs 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 Rock Hbs, then the stock price of the Rock Hbs 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 Rock Hbs 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.

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 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 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.

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Negotiation Strategy of Rock Health

References & Further Readings

Robert F. Higgins, Ian McKown Cornell (2018), "Rock Health Harvard Business Review Case Study. Published by HBR Publications.