Gates Foundation and Small High Schools 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 Gates Foundation and Small High Schools case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Gates Foundation and Small High Schools case study is a Harvard Business School (HBR) case study written by Stig Leschly. The Gates Foundation and Small High Schools (referred as “Foundation's Schools” 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, Organizational culture, Policy, Social enterprise.

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 Gates Foundation and Small High Schools Case Study

Covers the evolution of the Gates Foundation's multibillion dollar effort to influence reform in the U.S. public education system since 1999, particularly the foundation's recent decision to invest heavily in the breakup of existing urban high schools and the creation of new small high schools. Examines the merits of that strategy and various implementation issues associated with it. Tom Vander Ark, who oversees the foundation's education initiative, prepares for a meeting with Bill Gates in which he will review the foundation's track record and propose targeting future investments on small high school reform. For background and context, the case covers the contemporary small schools movement in the United States and the consolidation of high schools and districts in the United States since 2000.

Case Authors : Stig Leschly

Topic : Leadership & Managing People

Related Areas : Organizational culture, Policy, Social enterprise

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Calculating Net Present Value (NPV) at 6% for Gates Foundation and Small High Schools Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018036)	-10018036	-	-
Year 1	3454233	-6563803	3454233	0.9434	3258710
Year 2	3977784	-2586019	7432017	0.89	3540214
Year 3	3967439	1381420	11399456	0.8396	3331138
Year 4	3242816	4624236	14642272	0.7921	2568614
TOTAL			14642272		12698676

The Net Present Value at 6% discount rate is 2680640

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. Net Present Value
2. Payback Period
3. Profitability Index
4. Internal Rate of Return

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. Foundation's Schools 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 Foundation's Schools 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 Gates Foundation and Small High Schools

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 Foundation's Schools 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 Foundation's Schools 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	(10018036)	-10018036	-	-
Year 1	3454233	-6563803	3454233	0.8696	3003681
Year 2	3977784	-2586019	7432017	0.7561	3007776
Year 3	3967439	1381420	11399456	0.6575	2608656
Year 4	3242816	4624236	14642272	0.5718	1854091
TOTAL					10474203

The Net NPV after 4 years is 456167

(10474203 - 10018036 )

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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	(10018036)	-10018036	-	-
Year 1	3454233	-6563803	3454233	0.8333	2878528
Year 2	3977784	-2586019	7432017	0.6944	2762350
Year 3	3967439	1381420	11399456	0.5787	2295972
Year 4	3242816	4624236	14642272	0.4823	1563858
TOTAL					9500707

The Net NPV after 4 years is -517329

At 20% discount rate the NPV is negative (9500707 - 10018036 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Foundation's Schools 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 Foundation's Schools has a NPV value higher than Zero then finance managers at Foundation's Schools 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 Foundation's Schools, then the stock price of the Foundation's Schools 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 Foundation's Schools 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.

Understanding of risks involved in 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.

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 Gates Foundation and Small High Schools

References & Further Readings

Stig Leschly (2018), "Gates Foundation and Small High Schools Harvard Business Review Case Study. Published by HBR Publications.