William Levitt, Levittown and the Creation of American Suburbia 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 William Levitt, Levittown and the Creation of American Suburbia case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. William Levitt, Levittown and the Creation of American Suburbia case study is a Harvard Business School (HBR) case study written by Nitin Nohria, Anthony J. Mayo, Mark Benson. The William Levitt, Levittown and the Creation of American Suburbia (referred as “Levitt Sons” 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, Generational issues, Government, Growth strategy, Leadership, Marketing, Product development.

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 William Levitt, Levittown and the Creation of American Suburbia Case Study

Demand for low-cost housing after World War II far exceeded supply. Was this a profitable new market? New York developer William Levitt had to decide. During World War II, Levitt was eager to build basic housing for the working class--otherwise, Levitt & Sons would have been idle due to the federal government ban on all nonessential construction, like the luxury homes that Levitt & Sons typically built on Long Island, New York. Under a contract with the U.S. Navy, Levitt & Sons erected 2,000 homes in a year's time, an effort that gave Levitt & Sons the opportunity to perfect rapid home construction techniques. Levitt had to decide if he would apply those techniques to meet the post-war housing demand. Levitt & Sons had the manufacturing know-how. Would sizable profits follow? Levitt needed to understand the implications of the home improvement loans and mortgages the government guaranteed to returning servicemen as part of their veterans benefits. Levitt had the opportunity to parlay his own World War II experience as a Navy Seabee to market these homes by appealing to the sentiments of veterans like himself who were eager to return home and settle down after the fighting stopped. Levitt's decision would have profound social, economic, and political impact on the lives of returning veterans, their spouses, and their children--the Baby Boomers.

Case Authors : Nitin Nohria, Anthony J. Mayo, Mark Benson

Topic : Leadership & Managing People

Related Areas : Generational issues, Government, Growth strategy, Leadership, Marketing, Product development

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Calculating Net Present Value (NPV) at 6% for William Levitt, Levittown and the Creation of American Suburbia Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10022414)	-10022414	-	-
Year 1	3456354	-6566060	3456354	0.9434	3260711
Year 2	3975593	-2590467	7431947	0.89	3538264
Year 3	3969732	1379265	11401679	0.8396	3333064
Year 4	3251076	4630341	14652755	0.7921	2575157
TOTAL			14652755		12707195

The Net Present Value at 6% discount rate is 2684781

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. 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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Levitt Sons 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 Levitt Sons 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 William Levitt, Levittown and the Creation of American Suburbia

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 Levitt Sons 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 Levitt Sons 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	(10022414)	-10022414	-	-
Year 1	3456354	-6566060	3456354	0.8696	3005525
Year 2	3975593	-2590467	7431947	0.7561	3006119
Year 3	3969732	1379265	11401679	0.6575	2610163
Year 4	3251076	4630341	14652755	0.5718	1858813
TOTAL					10480621

The Net NPV after 4 years is 458207

(10480621 - 10022414 )

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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	(10022414)	-10022414	-	-
Year 1	3456354	-6566060	3456354	0.8333	2880295
Year 2	3975593	-2590467	7431947	0.6944	2760828
Year 3	3969732	1379265	11401679	0.5787	2297299
Year 4	3251076	4630341	14652755	0.4823	1567841
TOTAL					9506264

The Net NPV after 4 years is -516150

At 20% discount rate the NPV is negative (9506264 - 10022414 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Levitt Sons 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 Levitt Sons has a NPV value higher than Zero then finance managers at Levitt Sons 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 Levitt Sons, then the stock price of the Levitt Sons 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 Levitt Sons 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 can impact the cash flow of the project.

What will be a multi year spillover effect of various taxation regulations.

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.

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 William Levitt, Levittown and the Creation of American Suburbia

References & Further Readings

Nitin Nohria, Anthony J. Mayo, Mark Benson (2018), "William Levitt, Levittown and the Creation of American Suburbia Harvard Business Review Case Study. Published by HBR Publications.