Performance Management for Health in Washington State 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 Performance Management for Health in Washington State case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Performance Management for Health in Washington State case study is a Harvard Business School (HBR) case study written by Arnold Howitt, Jennifer Weeks. The Performance Management for Health in Washington State (referred as “Gmap Doh” 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, .

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 Performance Management for Health in Washington State Case Study

By the mid-2000s, Washington State's Department of Health (DOH) had earned a national reputation as an innovative and effective agency. But beginning in 2005, when newly elected Governor Christine Gregoire introduced a state-level performance management system - Government Management Accountability and Performance (GMAP) - DOH and other state entities found themselves having to regularly explain and justify their work through the newly established forum. Based on two similar, but smaller-scale programs - CompStat (created by the New York Police Department in 1994) and CitiStat (used by the City of Baltimore) - GMAP challenged public officials to analyze data in new ways and to rethink the kinds of results that they were accountable for delivering. This case provides background on GMAP's origins and on the general ways in which the initiative was managed, but it focuses primarily on DOH's efforts to comply with the new performance measurement requirements and to meet the expectations of the governor, her staff, and GMAP leadership. In exploring the benefits and challenges of the department's experience with GMAP, the case also raises questions about the applicability and usefulness of such a system for public health, which tends to address complex issues with objectives that are often difficult to quantify. Case number 1994.0

Case Authors : Arnold Howitt, Jennifer Weeks

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Performance Management for Health in Washington State Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10023045)	-10023045	-	-
Year 1	3471036	-6552009	3471036	0.9434	3274562
Year 2	3970843	-2581166	7441879	0.89	3534036
Year 3	3936818	1355652	11378697	0.8396	3305428
Year 4	3222466	4578118	14601163	0.7921	2552495
TOTAL			14601163		12666522

The Net Present Value at 6% discount rate is 2643477

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. Payback Period
2. Profitability Index
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. Gmap Doh 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 Gmap Doh 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 Performance Management for Health in Washington State

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 Gmap Doh 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 Gmap Doh 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	(10023045)	-10023045	-	-
Year 1	3471036	-6552009	3471036	0.8696	3018292
Year 2	3970843	-2581166	7441879	0.7561	3002528
Year 3	3936818	1355652	11378697	0.6575	2588522
Year 4	3222466	4578118	14601163	0.5718	1842455
TOTAL					10451797

The Net NPV after 4 years is 428752

(10451797 - 10023045 )

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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	(10023045)	-10023045	-	-
Year 1	3471036	-6552009	3471036	0.8333	2892530
Year 2	3970843	-2581166	7441879	0.6944	2757530
Year 3	3936818	1355652	11378697	0.5787	2278251
Year 4	3222466	4578118	14601163	0.4823	1554044
TOTAL					9482355

The Net NPV after 4 years is -540690

At 20% discount rate the NPV is negative (9482355 - 10023045 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Gmap Doh 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 Gmap Doh has a NPV value higher than Zero then finance managers at Gmap Doh 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 Gmap Doh, then the stock price of the Gmap Doh 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 Gmap Doh 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 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.

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 Performance Management for Health in Washington State

References & Further Readings

Arnold Howitt, Jennifer Weeks (2018), "Performance Management for Health in Washington State Harvard Business Review Case Study. Published by HBR Publications.