Jo Anne Heywood (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 Jo Anne Heywood (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Jo Anne Heywood (A) case study is a Harvard Business School (HBR) case study written by Garth Saloner, Angie Strange, Amanda West, Alexander Tauber. The Jo Anne Heywood (A) (referred as “Heywood Johnson” from here on) case study provides evaluation & decision scenario in field of Communication. It also touches upon business topics such as - Value proposition, Communication, Gender, Leadership, Sales.

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 Jo Anne Heywood (A) Case Study

Starts at the time Jo Anne Heywood was promoted to CEO of ConvergedNetworks. Heywood had just been hired as the CTO of ConvergedNetworks as the company prepared to raise its third round of financing. The board, however, had quickly realized that it also needed a CEO to raise this round, and Heywood was thus selected. Heywood and her team successfully closed a third round of financing. At the time ConvergedNetworks' board was courting Heywood, it was also hiring a new vice-president of sales, Dave Johnson. Heywood worried that Johnson may resent reporting to someone with no sales experience. As a result, Heywood felt she needed to manage Johnson carefully. Not long after assuming his role as VP of sales and closing the third round of financing, Johnson shared with Heywood his concerns about selling the product. After each customer meeting, Johnson began dropping his initial forecasts by 10% to 20%. As Heywood and Johnson prepared materials for the upcoming board meeting, Johnson suddenly admitted that his sales team would probably come in at 80% below his original projections. Heywood wondered how she should respond to Johnson and how she would approach the upcoming conversation with the board.

Case Authors : Garth Saloner, Angie Strange, Amanda West, Alexander Tauber

Topic : Communication

Related Areas : Communication, Gender, Leadership, Sales

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Calculating Net Present Value (NPV) at 6% for Jo Anne Heywood (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10014290)	-10014290	-	-
Year 1	3446116	-6568174	3446116	0.9434	3251053
Year 2	3961726	-2606448	7407842	0.89	3525922
Year 3	3950016	1343568	11357858	0.8396	3316510
Year 4	3222619	4566187	14580477	0.7921	2552616
TOTAL			14580477		12646101

The Net Present Value at 6% discount rate is 2631811

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. Profitability Index
3. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Heywood Johnson 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 Heywood Johnson 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 Jo Anne Heywood (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 Communication 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 Heywood Johnson 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 Heywood Johnson 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	(10014290)	-10014290	-	-
Year 1	3446116	-6568174	3446116	0.8696	2996623
Year 2	3961726	-2606448	7407842	0.7561	2995634
Year 3	3950016	1343568	11357858	0.6575	2597200
Year 4	3222619	4566187	14580477	0.5718	1842543
TOTAL					10431999

The Net NPV after 4 years is 417709

(10431999 - 10014290 )

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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	(10014290)	-10014290	-	-
Year 1	3446116	-6568174	3446116	0.8333	2871763
Year 2	3961726	-2606448	7407842	0.6944	2751199
Year 3	3950016	1343568	11357858	0.5787	2285889
Year 4	3222619	4566187	14580477	0.4823	1554118
TOTAL					9462969

The Net NPV after 4 years is -551321

At 20% discount rate the NPV is negative (9462969 - 10014290 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Heywood Johnson 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 Heywood Johnson has a NPV value higher than Zero then finance managers at Heywood Johnson 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 Heywood Johnson, then the stock price of the Heywood Johnson 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 Heywood Johnson 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 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.

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 Jo Anne Heywood (A)

References & Further Readings

Garth Saloner, Angie Strange, Amanda West, Alexander Tauber (2018), "Jo Anne Heywood (A) Harvard Business Review Case Study. Published by HBR Publications.