Royal Bank of Canada: Transforming Managers (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 Royal Bank of Canada: Transforming Managers (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Royal Bank of Canada: Transforming Managers (A) case study is a Harvard Business School (HBR) case study written by Kathryn Shaw, Debra Schifrin. The Royal Bank of Canada: Transforming Managers (A) (referred as “Managers Intervention” 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, Change management, Compensation, Human resource management, Organizational culture.

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 Royal Bank of Canada: Transforming Managers (A) Case Study

The 2015 case "Royal Bank of Canada: Transforming Managers (A)" discusses programs that the bank put in place between 2011 and 2013 to improve managerial effectiveness. The case looks at the traits that make good managers, how to use data to create visibility into managerial effectiveness, the features of a successful intervention action plan, and the challenges with finding ways to reward good managers. Specifically, the case focuses on a pilot intervention program within the Canadian Banking operations division that was designed by Human Resources thought leaders in collaboration with Canadian Banking operations' top leaders. The program had multiple parts: 1) Using an analytics model based on the employee opinion survey to rank all managers in the division based on effectiveness; 2) Dividing all managers into four effectiveness cohorts (roughly in quartiles); 3) Identifying the managers most in need of, and most likely to benefit from, manager effectiveness training; and 4) creating and carrying out action plans. The action plans included formal coaching by each of the targeted managers' managers (the most effective intervention), feedback, and formal training. The case concludes as the bank waits for the results of the next employee opinion survey to gauge how effective its management improvement programs were. The companion case, "Royal Bank of Canada: Transforming Managers (B)," discusses the results of the programs.

Case Authors : Kathryn Shaw, Debra Schifrin

Topic : Leadership & Managing People

Related Areas : Change management, Compensation, Human resource management, Organizational culture

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Calculating Net Present Value (NPV) at 6% for Royal Bank of Canada: Transforming Managers (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10008585)	-10008585	-	-
Year 1	3447130	-6561455	3447130	0.9434	3252009
Year 2	3958448	-2603007	7405578	0.89	3523005
Year 3	3939027	1336020	11344605	0.8396	3307283
Year 4	3247764	4583784	14592369	0.7921	2572533
TOTAL			14592369		12654830

The Net Present Value at 6% discount rate is 2646245

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. 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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Managers Intervention 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 Managers Intervention 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 Royal Bank of Canada: Transforming Managers (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 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 Managers Intervention 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 Managers Intervention 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	(10008585)	-10008585	-	-
Year 1	3447130	-6561455	3447130	0.8696	2997504
Year 2	3958448	-2603007	7405578	0.7561	2993155
Year 3	3939027	1336020	11344605	0.6575	2589974
Year 4	3247764	4583784	14592369	0.5718	1856920
TOTAL					10437554

The Net NPV after 4 years is 428969

(10437554 - 10008585 )

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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	(10008585)	-10008585	-	-
Year 1	3447130	-6561455	3447130	0.8333	2872608
Year 2	3958448	-2603007	7405578	0.6944	2748922
Year 3	3939027	1336020	11344605	0.5787	2279530
Year 4	3247764	4583784	14592369	0.4823	1566244
TOTAL					9467304

The Net NPV after 4 years is -541281

At 20% discount rate the NPV is negative (9467304 - 10008585 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Managers Intervention 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 Managers Intervention has a NPV value higher than Zero then finance managers at Managers Intervention 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 Managers Intervention, then the stock price of the Managers Intervention 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 Managers Intervention 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 can impact the cash flow of the project.

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.

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 Royal Bank of Canada: Transforming Managers (A)

References & Further Readings

Kathryn Shaw, Debra Schifrin (2018), "Royal Bank of Canada: Transforming Managers (A) Harvard Business Review Case Study. Published by HBR Publications.