BuildDirect: Constructing a Culture That Can Weather the Storms 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 BuildDirect: Constructing a Culture That Can Weather the Storms case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. BuildDirect: Constructing a Culture That Can Weather the Storms case study is a Harvard Business School (HBR) case study written by Robert I. Sutton, Hayagreeva Rao, Rebecca Hinds. The BuildDirect: Constructing a Culture That Can Weather the Storms (referred as “Builddirect Booth” 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, Growth strategy, Innovation, Leadership, Motivating people, Organizational culture, Organizational structure, Psychology.

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 BuildDirect: Constructing a Culture That Can Weather the Storms Case Study

After a delayed shipment of flooring materials impeded Jeff Booth's ability to complete a construction project on schedule, he, along with cofounder Robert Banks, was determined to solve the inefficiency of the heavyweight building supply industry. They founded BuildDirect, an e-commerce company based on a sophisticated technology platform that optimized the shipment of home improvement products. Since its founding in 1999, BuildDirect faced several near-death strategic and economic challenges, including the fallout of 9/11 and the 2008 housing crisis. In spite of these challenges, Booth and Banks never wavered in prioritizing corporate culture over bottom line results. To guide effective employee actions and behaviors, three core values of honesty, integrity, and respect for others had been engrained into the company's DNA. Rituals such as daily "huddles" strengthened employee morale, increased emotional intelligence, and enhanced customer service. Company culture was a major competitive advantage; employees felt empowered to view the home improvement purchase process as an enriching experience, rather than as a mere transaction. In 2014, prospects looked promising. BuildDirect had raised CAD $30 million in Series B funding in a round led by Mohr Davidow Ventures. Headcount doubled in 2013, and was projected to double again in 2014. Customers enjoyed savings of up to 80% of retail prices. Booth and Banks were concerned, however, that continued rapid growth would threaten the culture that was so critical to their success. The cofounders needed to determine how to maintain this winning culture. What aspects of the company's daily operations needed to be changed, and which ones safeguarded at all costs?

Case Authors : Robert I. Sutton, Hayagreeva Rao, Rebecca Hinds

Topic : Leadership & Managing People

Related Areas : Growth strategy, Innovation, Leadership, Motivating people, Organizational culture, Organizational structure, Psychology

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Calculating Net Present Value (NPV) at 6% for BuildDirect: Constructing a Culture That Can Weather the Storms Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10021568)	-10021568	-	-
Year 1	3467078	-6554490	3467078	0.9434	3270828
Year 2	3956164	-2598326	7423242	0.89	3520972
Year 3	3951582	1353256	11374824	0.8396	3317824
Year 4	3245005	4598261	14619829	0.7921	2570348
TOTAL			14619829		12679973

The Net Present Value at 6% discount rate is 2658405

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. Profitability Index
2. Payback Period
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Builddirect Booth 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 Builddirect Booth 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 BuildDirect: Constructing a Culture That Can Weather the Storms

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 Builddirect Booth 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 Builddirect Booth 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	(10021568)	-10021568	-	-
Year 1	3467078	-6554490	3467078	0.8696	3014850
Year 2	3956164	-2598326	7423242	0.7561	2991428
Year 3	3951582	1353256	11374824	0.6575	2598229
Year 4	3245005	4598261	14619829	0.5718	1855342
TOTAL					10459850

The Net NPV after 4 years is 438282

(10459850 - 10021568 )

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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	(10021568)	-10021568	-	-
Year 1	3467078	-6554490	3467078	0.8333	2889232
Year 2	3956164	-2598326	7423242	0.6944	2747336
Year 3	3951582	1353256	11374824	0.5787	2286795
Year 4	3245005	4598261	14619829	0.4823	1564914
TOTAL					9488277

The Net NPV after 4 years is -533291

At 20% discount rate the NPV is negative (9488277 - 10021568 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Builddirect Booth 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 Builddirect Booth has a NPV value higher than Zero then finance managers at Builddirect Booth 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 Builddirect Booth, then the stock price of the Builddirect Booth 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 Builddirect Booth 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 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.

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.

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 BuildDirect: Constructing a Culture That Can Weather the Storms

References & Further Readings

Robert I. Sutton, Hayagreeva Rao, Rebecca Hinds (2018), "BuildDirect: Constructing a Culture That Can Weather the Storms Harvard Business Review Case Study. Published by HBR Publications.