Two Brattle Center: A Mental-Health Clinic in Search of a Viable Operating Model 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 Two Brattle Center: A Mental-Health Clinic in Search of a Viable Operating Model case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Two Brattle Center: A Mental-Health Clinic in Search of a Viable Operating Model case study is a Harvard Business School (HBR) case study written by Robert G. Eccles. The Two Brattle Center: A Mental-Health Clinic in Search of a Viable Operating Model (referred as “Tbc Wheelis” 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, Personnel policies.

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 Two Brattle Center: A Mental-Health Clinic in Search of a Viable Operating Model Case Study

Two Brattle Center (TBC) is a struggling for-profit private mental health clinic based in Harvard Square. Its founder, Dr. Joan Wheelis, is a nationally recognized practicing psychiatrist who has developed outpatient treatment programs based on Dialectical Behavior Therapy (DBT) for patients with borderline personality disorder (BPD). These patients, typically adolescent girls and young women, struggle with emotional crises and are prone to destructive behaviors such as cutting, excessive use of alcohol, taking drugs and suicide attempts. These patients are very difficult to treat and TBC has developed programs that make a noticeable difference to these patients. DBT requires teams of people with different types of expertise and so the original operating model developed by Dr. Wheelis was one in which TBC was staffed by a large number of part-time clinicians, the "affiliate model." However, changes in the health care environment, particularly the advent of managed care, have put very real pressures on this model and the company is now in a state of crisis. Dr. Wheelis is trying to decide whether and how to keep it going. The key decision is whether to shift to a "staffing model" based on a larger number of full-time clinicians. This will require a larger patient population to make the economics of greater fixed capacity viable. Another constraint is the poor state of its basic financial systems. Morale is low and thus staff turnover is high, with many clinicians taking patients with them into their private practice when they go. TBC is trying to decide whether to join the Blue Cross Blue Shield network, which would increase its patient population but at rates much lower than it currently charges by only taking private patients. Dr. Wheelis is also pondering whether to start a non-profit foundation as a way of getting money to support its teaching and training programs, or even making the company a non-profit itself.

Case Authors : Robert G. Eccles

Topic : Leadership & Managing People

Related Areas : Personnel policies

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Calculating Net Present Value (NPV) at 6% for Two Brattle Center: A Mental-Health Clinic in Search of a Viable Operating Model Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018237)	-10018237	-	-
Year 1	3452302	-6565935	3452302	0.9434	3256889
Year 2	3976065	-2589870	7428367	0.89	3538684
Year 3	3952728	1362858	11381095	0.8396	3318787
Year 4	3241994	4604852	14623089	0.7921	2567963
TOTAL			14623089		12682322

The Net Present Value at 6% discount rate is 2664085

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. Internal Rate of Return
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. Tbc Wheelis 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 Tbc Wheelis 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 Two Brattle Center: A Mental-Health Clinic in Search of a Viable Operating Model

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 Tbc Wheelis 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 Tbc Wheelis 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	(10018237)	-10018237	-	-
Year 1	3452302	-6565935	3452302	0.8696	3002002
Year 2	3976065	-2589870	7428367	0.7561	3006476
Year 3	3952728	1362858	11381095	0.6575	2598983
Year 4	3241994	4604852	14623089	0.5718	1853621
TOTAL					10461082

The Net NPV after 4 years is 442845

(10461082 - 10018237 )

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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	(10018237)	-10018237	-	-
Year 1	3452302	-6565935	3452302	0.8333	2876918
Year 2	3976065	-2589870	7428367	0.6944	2761156
Year 3	3952728	1362858	11381095	0.5787	2287458
Year 4	3241994	4604852	14623089	0.4823	1563462
TOTAL					9488995

The Net NPV after 4 years is -529242

At 20% discount rate the NPV is negative (9488995 - 10018237 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Tbc Wheelis 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 Tbc Wheelis has a NPV value higher than Zero then finance managers at Tbc Wheelis 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 Tbc Wheelis, then the stock price of the Tbc Wheelis 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 Tbc Wheelis 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 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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in 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 Two Brattle Center: A Mental-Health Clinic in Search of a Viable Operating Model

References & Further Readings

Robert G. Eccles (2018), "Two Brattle Center: A Mental-Health Clinic in Search of a Viable Operating Model Harvard Business Review Case Study. Published by HBR Publications.