The Flawed Emergency Response to the 1992 Los Angeles Riots (A) 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 The Flawed Emergency Response to the 1992 Los Angeles Riots (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Flawed Emergency Response to the 1992 Los Angeles Riots (A) case study is a Harvard Business School (HBR) case study written by Richard Falkenrath, Susan Rosegrant. The The Flawed Emergency Response to the 1992 Los Angeles Riots (A) (referred as “Riot Response” 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 The Flawed Emergency Response to the 1992 Los Angeles Riots (A) Case Study

When a jury acquitted four Los Angeles police officers in the famous, videotaped beating of a black motorist stopped for speeding, the decision sparked shock, outrage and, in short order riot in the city's African-American South Central section. The six days of unrest that ensued left a staggering toll: 54 dead, more than 2,000 injured, and property damage of almost $1 billion. This case describes the law enforcement response to the riot, raising, in effect, the question of whether, through a different type of response, the unrest could have been controlled more quickly and damage and casualties minimized. The case provides, in some instances for the first time, a detailed look at both the plans and responses of specific law enforcement and emergency response units including the LAPD and fire department, the LA County Sheriff's office, and the California National Guard. It describes key assumptions which proved faulty, problematic inter-agency coordination, as well as heroic individual efforts by some within those departments, which helped restore order.

Case Authors : Richard Falkenrath, Susan Rosegrant

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for The Flawed Emergency Response to the 1992 Los Angeles Riots (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10010942)	-10010942	-	-
Year 1	3466270	-6544672	3466270	0.9434	3270066
Year 2	3955244	-2589428	7421514	0.89	3520153
Year 3	3940966	1351538	11362480	0.8396	3308911
Year 4	3224864	4576402	14587344	0.7921	2554394
TOTAL			14587344		12653525

The Net Present Value at 6% discount rate is 2642583

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. Net Present Value
3. Internal Rate of Return
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. Riot Response 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 Riot Response 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 The Flawed Emergency Response to the 1992 Los Angeles Riots (A)

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 Riot Response 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 Riot Response 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	(10010942)	-10010942	-	-
Year 1	3466270	-6544672	3466270	0.8696	3014148
Year 2	3955244	-2589428	7421514	0.7561	2990733
Year 3	3940966	1351538	11362480	0.6575	2591249
Year 4	3224864	4576402	14587344	0.5718	1843826
TOTAL					10439956

The Net NPV after 4 years is 429014

(10439956 - 10010942 )

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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	(10010942)	-10010942	-	-
Year 1	3466270	-6544672	3466270	0.8333	2888558
Year 2	3955244	-2589428	7421514	0.6944	2746697
Year 3	3940966	1351538	11362480	0.5787	2280652
Year 4	3224864	4576402	14587344	0.4823	1555201
TOTAL					9471108

The Net NPV after 4 years is -539834

At 20% discount rate the NPV is negative (9471108 - 10010942 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Riot Response 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 Riot Response has a NPV value higher than Zero then finance managers at Riot Response 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 Riot Response, then the stock price of the Riot Response 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 Riot Response 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 –

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.

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

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 The Flawed Emergency Response to the 1992 Los Angeles Riots (A)

References & Further Readings

Richard Falkenrath, Susan Rosegrant (2018), "The Flawed Emergency Response to the 1992 Los Angeles Riots (A) Harvard Business Review Case Study. Published by HBR Publications.