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Transformation of Seattle Public Schools--1995-2002 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 Transformation of Seattle Public Schools--1995-2002 case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Transformation of Seattle Public Schools--1995-2002 case study is a Harvard Business School (HBR) case study written by Stig Leschly. The Transformation of Seattle Public Schools--1995-2002 (referred as “Reform District's” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Leadership, Organizational structure.

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 Transformation of Seattle Public Schools--1995-2002 Case Study


Investigates the reform of the Seattle Public Schools from 1995 to 2002. To initiate reform in 1995, the district hired John Stanford, an Army general, and Joseph Olchefske, an investment banker, as the district's superintendent and chief financial officer, respectively. Under the direction of Stanford and Olchefske, the district launched a long-term reform plan, the centerpieces of which were influenced by market theory and general management principles. The first priority of the reform plan was to decentralize the district's budgeting process. Decentralization, referred to locally as the Freedom Agenda, reduced the involvement of the district's central office in school-based activities and delegated to individual school principals increased flexibility in managing resources, hiring staff, and designing education programs. The aim of the Freedom Agenda was to equip principals and their leadership teams with the resources and authority they needed to implement educational programs tailored to individual student needs. A second phase of the reform, known in the district as the Performance Agenda, set academic standards for students and defined professional expectations for teachers and administrators. A primary goal of the Performance Agenda was to align teaching practices with clearly defined academic outcomes for students and to introduce performance-based practices into the management of teachers and staff.


Case Authors : Stig Leschly

Topic : Leadership & Managing People

Related Areas : Leadership, Organizational structure




Calculating Net Present Value (NPV) at 6% for Transformation of Seattle Public Schools--1995-2002 Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10009428) -10009428 - -
Year 1 3446938 -6562490 3446938 0.9434 3251828
Year 2 3959825 -2602665 7406763 0.89 3524230
Year 3 3961781 1359116 11368544 0.8396 3326388
Year 4 3242722 4601838 14611266 0.7921 2568540
TOTAL 14611266 12670986


The Net Present Value at 6% discount rate is 2661558

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. Profitability Index
2. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Reform District's 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 Reform District's 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 Transformation of Seattle Public Schools--1995-2002

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 Leadership & Managing People 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 Reform District's 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 Reform District's 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 (10009428) -10009428 - -
Year 1 3446938 -6562490 3446938 0.8696 2997337
Year 2 3959825 -2602665 7406763 0.7561 2994197
Year 3 3961781 1359116 11368544 0.6575 2604935
Year 4 3242722 4601838 14611266 0.5718 1854037
TOTAL 10450506


The Net NPV after 4 years is 441078

(10450506 - 10009428 )






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 (10009428) -10009428 - -
Year 1 3446938 -6562490 3446938 0.8333 2872448
Year 2 3959825 -2602665 7406763 0.6944 2749878
Year 3 3961781 1359116 11368544 0.5787 2292697
Year 4 3242722 4601838 14611266 0.4823 1563813
TOTAL 9478837


The Net NPV after 4 years is -530591

At 20% discount rate the NPV is negative (9478837 - 10009428 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Reform District's 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 Reform District's has a NPV value higher than Zero then finance managers at Reform District's 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 Reform District's, then the stock price of the Reform District's 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 Reform District's 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 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.

Understanding of risks involved in 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.




References & Further Readings

Stig Leschly (2018), "Transformation of Seattle Public Schools--1995-2002 Harvard Business Review Case Study. Published by HBR Publications.