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Linda Rabbitt at rand* construction 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 Linda Rabbitt at rand* construction case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Linda Rabbitt at rand* construction case study is a Harvard Business School (HBR) case study written by Boris Groysberg, Katherine Connolly. The Linda Rabbitt at rand* construction (referred as “Rabbitt Couch” 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, Gender, Leadership, Organizational culture, Succession planning.

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 Linda Rabbitt at rand* construction Case Study


Linda Rabbitt, founder and CEO of rand* construction walked into her office at the company's headquarters in Alexandria, VA and briefly closed the door behind her. It was 10:00 a.m. on Monday, September 22, 2014, and she had just addressed her staff after the sudden and tragic death of the company's well-loved President, Jon Couch, the previous Friday afternoon. It had been an emotional address, as Rabbitt tried to inspire the company to move forward while holding back her own tears. For Rabbitt and for everyone else at the company, the loss was both professional and personal. Furthermore, Couch's death signified for Rabbitt the loss of her entire succession plan. Now in her mid-60s, Rabbitt was preparing to turn over the reins of the company to Couch, whom she had partnered with and mentored for eighteen years. What should Rabbitt do now? What should she plan for the future now that Couch was gone?


Case Authors : Boris Groysberg, Katherine Connolly

Topic : Leadership & Managing People

Related Areas : Gender, Leadership, Organizational culture, Succession planning




Calculating Net Present Value (NPV) at 6% for Linda Rabbitt at rand* construction Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10021040) -10021040 - -
Year 1 3470200 -6550840 3470200 0.9434 3273774
Year 2 3953049 -2597791 7423249 0.89 3518200
Year 3 3951843 1354052 11375092 0.8396 3318044
Year 4 3231508 4585560 14606600 0.7921 2559657
TOTAL 14606600 12669674


The Net Present Value at 6% discount rate is 2648634

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. Net Present Value
3. Internal Rate of Return
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 Rabbitt Couch 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. Rabbitt Couch 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 Linda Rabbitt at rand* construction

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 Rabbitt Couch 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 Rabbitt Couch 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 (10021040) -10021040 - -
Year 1 3470200 -6550840 3470200 0.8696 3017565
Year 2 3953049 -2597791 7423249 0.7561 2989073
Year 3 3951843 1354052 11375092 0.6575 2598401
Year 4 3231508 4585560 14606600 0.5718 1847625
TOTAL 10452664


The Net NPV after 4 years is 431624

(10452664 - 10021040 )






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 (10021040) -10021040 - -
Year 1 3470200 -6550840 3470200 0.8333 2891833
Year 2 3953049 -2597791 7423249 0.6944 2745173
Year 3 3951843 1354052 11375092 0.5787 2286946
Year 4 3231508 4585560 14606600 0.4823 1558405
TOTAL 9482357


The Net NPV after 4 years is -538683

At 20% discount rate the NPV is negative (9482357 - 10021040 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Rabbitt Couch 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 Rabbitt Couch has a NPV value higher than Zero then finance managers at Rabbitt Couch 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 Rabbitt Couch, then the stock price of the Rabbitt Couch 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 Rabbitt Couch 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 will be a multi year spillover effect of various taxation regulations.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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.

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, Katherine Connolly (2018), "Linda Rabbitt at rand* construction Harvard Business Review Case Study. Published by HBR Publications.