Pine Street Initiative at Goldman Sachs 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 Pine Street Initiative at Goldman Sachs case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Pine Street Initiative at Goldman Sachs case study is a Harvard Business School (HBR) case study written by Boris Groysberg, Scott A. Snook, David Lane. The Pine Street Initiative at Goldman Sachs (referred as “Pine Street” 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, Leadership development, Organizational structure.

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

Case Description of Pine Street Initiative at Goldman Sachs Case Study

Almost five years had passed since Goldman Sachs launched its innovative leadership development initiative called Pine Street. Focused primarily on developing Goldman's most senior managers, Pine Street had evolved significantly since its inception in November of 1999. Looking forward, there were a number of challenges. How would Pine Street remain valued in a culture where what you did yesterday doesn't matter much? The question every day is "What will you do for me today?" Early in May 2005, members of the Pine Street Board of Directors gathered for their quarterly meeting to address the dimensions of this challenge: First, its curriculum had to maintain the interest of an increasingly demanding internal clientele. Second, program content had to keep pace with the constantly changing requirements of a rapidly shifting competitive and regulator landscape. Third, Pine Street itself had to pursue creative ways of renewing its structure and people without compromising either its mission or its unique culture. Fourth, Pine Street had to retain the continued support of Goldman Sachs' senior leadership. Finally, as program offerings grew, so did fundamental questions of identity: After five years of evolutionary growth, what did the Pine Street brand mean to Goldman Sachs?

Case Authors : Boris Groysberg, Scott A. Snook, David Lane

Topic : Leadership & Managing People

Related Areas : Leadership development, Organizational structure

Calculating Net Present Value (NPV) at 6% for Pine Street Initiative at Goldman Sachs Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10016006) -10016006 - -
Year 1 3451691 -6564315 3451691 0.9434 3256312
Year 2 3971668 -2592647 7423359 0.89 3534770
Year 3 3958264 1365617 11381623 0.8396 3323435
Year 4 3240845 4606462 14622468 0.7921 2567053
TOTAL 14622468 12681570

The Net Present Value at 6% discount rate is 2665564

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.

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. 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 Pine Street 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. Pine Street shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

Formula and Steps to Calculate Net Present Value (NPV) of Pine Street Initiative at Goldman Sachs

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 Pine Street 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 Pine Street 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 %
Cash Flows
Year 0 (10016006) -10016006 - -
Year 1 3451691 -6564315 3451691 0.8696 3001470
Year 2 3971668 -2592647 7423359 0.7561 3003152
Year 3 3958264 1365617 11381623 0.6575 2602623
Year 4 3240845 4606462 14622468 0.5718 1852964
TOTAL 10460209

The Net NPV after 4 years is 444203

(10460209 - 10016006 )

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 %
Cash Flows
Year 0 (10016006) -10016006 - -
Year 1 3451691 -6564315 3451691 0.8333 2876409
Year 2 3971668 -2592647 7423359 0.6944 2758103
Year 3 3958264 1365617 11381623 0.5787 2290662
Year 4 3240845 4606462 14622468 0.4823 1562908
TOTAL 9488081

The Net NPV after 4 years is -527925

At 20% discount rate the NPV is negative (9488081 - 10016006 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Pine Street 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 Pine Street has a NPV value higher than Zero then finance managers at Pine Street 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 Pine Street, then the stock price of the Pine Street 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 Pine Street 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.

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.

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.

References & Further Readings

Boris Groysberg, Scott A. Snook, David Lane (2018), "Pine Street Initiative at Goldman Sachs Harvard Business Review Case Study. Published by HBR Publications.