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Paragon Legal: A New Model (A) 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 Paragon Legal: A New Model (A) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Paragon Legal: A New Model (A) case study is a Harvard Business School (HBR) case study written by Sarah A Soule, Shelley J Correll, Debra Schifrin. The Paragon Legal: A New Model (A) (referred as “Paragon Legal” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Work-life balance.

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 Paragon Legal: A New Model (A) Case Study


The case is about the San Francisco-based law firm, Paragon Legal, founded by lawyer and entrepreneur Mae O'Malley. Paragon Legal gave high-level attorneys the opportunity to have a flexible schedule and work 10 to 40 hours a week. This was in the context of an industry that typically required very long hours and had inflexible schedules and serious penalties for stepping out of the field for any length of time. Eighty-five percent of Paragon Legal attorneys were women with children, but the firm also attracted women and men without children who wanted to find a work/life balance. Paragon Legal lawyers were contract workers and received competitive compensation. In addition to discussing Paragon Legal, the case details the landscape of the legal industry, including challenges and pressures on all attorneys and the additional challenges for women. By the summer of 2010, Paragon Legal had become successful in the San Francisco Bay Area, and the question posed in the (A) case is whether the company should scale within the region and/or geographically. And if so, what would that look like? Other topics of discussion in the case include: the nature of contract work, entrepreneurship (and female entrepreneurship), and redesigning work for a better work/life balance.


Case Authors : Sarah A Soule, Shelley J Correll, Debra Schifrin

Topic : Innovation & Entrepreneurship

Related Areas : Work-life balance




Calculating Net Present Value (NPV) at 6% for Paragon Legal: A New Model (A) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10014543) -10014543 - -
Year 1 3465005 -6549538 3465005 0.9434 3268873
Year 2 3970404 -2579134 7435409 0.89 3533645
Year 3 3938360 1359226 11373769 0.8396 3306723
Year 4 3244679 4603905 14618448 0.7921 2570090
TOTAL 14618448 12679331




The Net Present Value at 6% discount rate is 2664788

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. Internal Rate of Return
2. Profitability Index
3. Net Present Value
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. Timing of the expected cash flows – stockholders of Paragon Legal 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. Paragon Legal shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of Paragon Legal: A New Model (A)

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 Paragon Legal 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 Paragon Legal 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 (10014543) -10014543 - -
Year 1 3465005 -6549538 3465005 0.8696 3013048
Year 2 3970404 -2579134 7435409 0.7561 3002196
Year 3 3938360 1359226 11373769 0.6575 2589536
Year 4 3244679 4603905 14618448 0.5718 1855156
TOTAL 10459935


The Net NPV after 4 years is 445392

(10459935 - 10014543 )








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 (10014543) -10014543 - -
Year 1 3465005 -6549538 3465005 0.8333 2887504
Year 2 3970404 -2579134 7435409 0.6944 2757225
Year 3 3938360 1359226 11373769 0.5787 2279144
Year 4 3244679 4603905 14618448 0.4823 1564756
TOTAL 9488629


The Net NPV after 4 years is -525914

At 20% discount rate the NPV is negative (9488629 - 10014543 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Paragon Legal 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 Paragon Legal has a NPV value higher than Zero then finance managers at Paragon Legal 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 Paragon Legal, then the stock price of the Paragon Legal 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 Paragon Legal 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 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.

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 Paragon Legal: A New Model (A)

References & Further Readings

Sarah A Soule, Shelley J Correll, Debra Schifrin (2018), "Paragon Legal: A New Model (A) Harvard Business Review Case Study. Published by HBR Publications.


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