To What End? Re-thinking Terrorist Attack Exercises in San Jose (Sequel 1) 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 To What End? Re-thinking Terrorist Attack Exercises in San Jose (Sequel 1) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. To What End? Re-thinking Terrorist Attack Exercises in San Jose (Sequel 1) case study is a Harvard Business School (HBR) case study written by Pamela Varley, Arnold Howitt. The To What End? Re-thinking Terrorist Attack Exercises in San Jose (Sequel 1) (referred as “Jose San” 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, Government, Project management, Risk management, Security & privacy, Strategic planning, Workspaces.

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 To What End? Re-thinking Terrorist Attack Exercises in San Jose (Sequel 1) Case Study

This case study tells the story of San Jose, California, one of the first 27 cities in the country to participate in a federal domestic preparedness program. Between 1997 and 1999, a specially created city task force mounted several full-scale terrorist attack exercises, but-despite the best of intentions-found all of them frustrating, demoralizing, and divisive, creating ill will between the exercise planners and the first responders. In response, the San Jose task force took a step back and analyzed their situation. In place of traditional full-scale exercises, San Jose drew on several existing prototypes to create a new "facilitated exercise" model that emphasized teaching over testing, and was much better received by first responders. For teaching flexibility, the case has been divided into three parts. Sequel 1 is a continuation of the main case study (1815.0) and is designed to be read in the middle of class. It describes the new facilitated exercise model in brief. Students could then be asked to assess the approach taken by San Jose. HKS Case Number 1815.1

Case Authors : Pamela Varley, Arnold Howitt

Topic : Leadership & Managing People

Related Areas : Government, Project management, Risk management, Security & privacy, Strategic planning, Workspaces

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Calculating Net Present Value (NPV) at 6% for To What End? Re-thinking Terrorist Attack Exercises in San Jose (Sequel 1) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10011074)	-10011074	-	-
Year 1	3473067	-6538007	3473067	0.9434	3276478
Year 2	3980486	-2557521	7453553	0.89	3542618
Year 3	3966865	1409344	11420418	0.8396	3330656
Year 4	3251064	4660408	14671482	0.7921	2575147
TOTAL			14671482		12724900

The Net Present Value at 6% discount rate is 2713826

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. Payback Period
3. Net Present Value
4. Profitability Index

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. Timing of the expected cash flows – stockholders of Jose San have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Jose San shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of To What End? Re-thinking Terrorist Attack Exercises in San Jose (Sequel 1)

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 Jose San 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 Jose San 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	(10011074)	-10011074	-	-
Year 1	3473067	-6538007	3473067	0.8696	3020058
Year 2	3980486	-2557521	7453553	0.7561	3009819
Year 3	3966865	1409344	11420418	0.6575	2608278
Year 4	3251064	4660408	14671482	0.5718	1858806
TOTAL					10496962

The Net NPV after 4 years is 485888

(10496962 - 10011074 )

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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	(10011074)	-10011074	-	-
Year 1	3473067	-6538007	3473067	0.8333	2894223
Year 2	3980486	-2557521	7453553	0.6944	2764226
Year 3	3966865	1409344	11420418	0.5787	2295639
Year 4	3251064	4660408	14671482	0.4823	1567836
TOTAL					9521924

The Net NPV after 4 years is -489150

At 20% discount rate the NPV is negative (9521924 - 10011074 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Jose San 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 Jose San has a NPV value higher than Zero then finance managers at Jose San 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 Jose San, then the stock price of the Jose San 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 Jose San 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 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.

What can impact the cash flow of the project.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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 To What End? Re-thinking Terrorist Attack Exercises in San Jose (Sequel 1)

References & Further Readings

Pamela Varley, Arnold Howitt (2018), "To What End? Re-thinking Terrorist Attack Exercises in San Jose (Sequel 1) Harvard Business Review Case Study. Published by HBR Publications.