The Bridgespan Group: Chapter 2 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 Bridgespan Group: Chapter 2 case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Bridgespan Group: Chapter 2 case study is a Harvard Business School (HBR) case study written by Allen Grossman, Naomi Greckol-Herlich, Catherine Ross. The The Bridgespan Group: Chapter 2 (referred as “Bridgespan Bridgespan's” 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, Knowledge management, Social responsibility.

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 Bridgespan Group: Chapter 2 Case Study

The Bridgespan Group was launched in 2000 by management consulting group Bain & Company as a nonprofit focused on strategy consulting for nonprofits and philanthropists. Over the next eight years, Bridgespan expanded its services to include executive search, knowledge sharing, and a web-based job matching service. While its growth was welcome, Bridgespan's leaders and board wanted to strengthen Bridgespan's positive impact on the nonprofit sector as a whole.

Case Authors : Allen Grossman, Naomi Greckol-Herlich, Catherine Ross

Topic : Leadership & Managing People

Related Areas : Knowledge management, Social responsibility

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Calculating Net Present Value (NPV) at 6% for The Bridgespan Group: Chapter 2 Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012538)	-10012538	-	-
Year 1	3469649	-6542889	3469649	0.9434	3273254
Year 2	3958487	-2584402	7428136	0.89	3523039
Year 3	3946590	1362188	11374726	0.8396	3313633
Year 4	3248720	4610908	14623446	0.7921	2573291
TOTAL			14623446		12683217

The Net Present Value at 6% discount rate is 2670679

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. Internal Rate of Return
3. Profitability Index
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. Timing of the expected cash flows – stockholders of Bridgespan Bridgespan's 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. Bridgespan Bridgespan's 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 The Bridgespan Group: Chapter 2

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 Bridgespan Bridgespan's 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 Bridgespan Bridgespan's 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	(10012538)	-10012538	-	-
Year 1	3469649	-6542889	3469649	0.8696	3017086
Year 2	3958487	-2584402	7428136	0.7561	2993185
Year 3	3946590	1362188	11374726	0.6575	2594947
Year 4	3248720	4610908	14623446	0.5718	1857466
TOTAL					10462684

The Net NPV after 4 years is 450146

(10462684 - 10012538 )

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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	(10012538)	-10012538	-	-
Year 1	3469649	-6542889	3469649	0.8333	2891374
Year 2	3958487	-2584402	7428136	0.6944	2748949
Year 3	3946590	1362188	11374726	0.5787	2283906
Year 4	3248720	4610908	14623446	0.4823	1566705
TOTAL					9490935

The Net NPV after 4 years is -521603

At 20% discount rate the NPV is negative (9490935 - 10012538 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Bridgespan Bridgespan's 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 Bridgespan Bridgespan's has a NPV value higher than Zero then finance managers at Bridgespan Bridgespan's 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 Bridgespan Bridgespan's, then the stock price of the Bridgespan Bridgespan's 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 Bridgespan Bridgespan's 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 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.

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.

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 Bridgespan Group: Chapter 2

References & Further Readings

Allen Grossman, Naomi Greckol-Herlich, Catherine Ross (2018), "The Bridgespan Group: Chapter 2 Harvard Business Review Case Study. Published by HBR Publications.