×




John Jacob Astor, 1763-1848 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 John Jacob Astor, 1763-1848 case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. John Jacob Astor, 1763-1848 case study is a Harvard Business School (HBR) case study written by Thomas K. McCraw. The John Jacob Astor, 1763-1848 (referred as “Astor 1763” 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, Global strategy.

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 John Jacob Astor, 1763-1848 Case Study


Astor, the wealthiest American of his time, engages in fur trading, shipping, real estate investment, and general merchandise trading. Astor's career illustrates the immediate pre-modern management era: types of decisions, time horizons, and number of transactions.


Case Authors : Thomas K. McCraw

Topic : Leadership & Managing People

Related Areas : Global strategy




Calculating Net Present Value (NPV) at 6% for John Jacob Astor, 1763-1848 Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10022509) -10022509 - -
Year 1 3443537 -6578972 3443537 0.9434 3248620
Year 2 3970151 -2608821 7413688 0.89 3533420
Year 3 3947304 1338483 11360992 0.8396 3314233
Year 4 3247744 4586227 14608736 0.7921 2572517
TOTAL 14608736 12668790




The Net Present Value at 6% discount rate is 2646281

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. Internal Rate of Return
2. Net Present Value
3. Payback Period
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 Astor 1763 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. Astor 1763 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 John Jacob Astor, 1763-1848

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 Astor 1763 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 Astor 1763 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 (10022509) -10022509 - -
Year 1 3443537 -6578972 3443537 0.8696 2994380
Year 2 3970151 -2608821 7413688 0.7561 3002005
Year 3 3947304 1338483 11360992 0.6575 2595416
Year 4 3247744 4586227 14608736 0.5718 1856908
TOTAL 10448709


The Net NPV after 4 years is 426200

(10448709 - 10022509 )








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 (10022509) -10022509 - -
Year 1 3443537 -6578972 3443537 0.8333 2869614
Year 2 3970151 -2608821 7413688 0.6944 2757049
Year 3 3947304 1338483 11360992 0.5787 2284319
Year 4 3247744 4586227 14608736 0.4823 1566235
TOTAL 9477217


The Net NPV after 4 years is -545292

At 20% discount rate the NPV is negative (9477217 - 10022509 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Astor 1763 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 Astor 1763 has a NPV value higher than Zero then finance managers at Astor 1763 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 Astor 1763, then the stock price of the Astor 1763 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 Astor 1763 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.

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 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.






Negotiation Strategy of John Jacob Astor, 1763-1848

References & Further Readings

Thomas K. McCraw (2018), "John Jacob Astor, 1763-1848 Harvard Business Review Case Study. Published by HBR Publications.


FutureLand SWOT Analysis / TOWS Matrix

Consumer/Non-Cyclical , Crops


SiS Intl SWOT Analysis / TOWS Matrix

Technology , Computer Peripherals


Alphageo India Ltd SWOT Analysis / TOWS Matrix

Energy , Oil Well Services & Equipment


ITV SWOT Analysis / TOWS Matrix

Services , Broadcasting & Cable TV


WFD Unibail Rodamco SWOT Analysis / TOWS Matrix

Services , Real Estate Operations


Tera Semicon SWOT Analysis / TOWS Matrix

Capital Goods , Misc. Capital Goods


TDH Holdings SWOT Analysis / TOWS Matrix

Consumer/Non-Cyclical , Food Processing


Hankuk Paper SWOT Analysis / TOWS Matrix

Basic Materials , Paper & Paper Products


Nuveen Muni Credit SWOT Analysis / TOWS Matrix

Financial , Misc. Financial Services