The Executive's Role in Social Business 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 The Executive's Role in Social Business case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Executive's Role in Social Business case study is a Harvard Business School (HBR) case study written by David Kiron, Douglas Palmer, Anh Nguyen Phillips, Robert Berkman. The The Executive's Role in Social Business (referred as “Social Initiatives” 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, .

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 The Executive's Role in Social Business Case Study

This is an MIT Sloan Management Review article. Social technologies are becoming more important to business, according to a survey conducted by MIT Sloan Management Review and Deloitte. However, the adoption of social technologies often means changing the way people work, and that means executives need to invest time and effort in explaining the purpose and value of using the new tools, as well as providing the necessary financial and organizational supports to sustain these work flow changes over time. The authors'research is based on two surveys conducted in 2011 and 2012, as well as dozens of interviews with executives and social business thought leaders. The 2012 survey had more than 2,500 respondents from 25 industries and 99 countries. According to its findings, 52% of managers say their companies are at an early stage of developing social capabilities. For these managers, the top barriers to using social business are a lack of strategy, no business case and a lack of management understanding. The authors explain the importance of three types of senior leadership support for initiatives that rely on social technologies: (1) support for these initiatives over time, not just when they are launched, (2) executives'own use of social technologies as a signal of their importance, and (3) a pragmatic attitude about what to measure and when to measure results from these initiatives. As marketers capitalize on social tools, the relationship between CMOs and CIOs can change, and some organizations are hiring chief digital officers, the authors note. They observe that successful social business initiatives can produce changes in the way executives work together.

Case Authors : David Kiron, Douglas Palmer, Anh Nguyen Phillips, Robert Berkman

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for The Executive's Role in Social Business Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10003242)	-10003242	-	-
Year 1	3472960	-6530282	3472960	0.9434	3276377
Year 2	3978956	-2551326	7451916	0.89	3541257
Year 3	3965147	1413821	11417063	0.8396	3329214
Year 4	3241663	4655484	14658726	0.7921	2567701
TOTAL			14658726		12714549

The Net Present Value at 6% discount rate is 2711307

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. Internal Rate of Return
2. Profitability Index
3. Net Present Value
4. Payback Period

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

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Formula and Steps to Calculate Net Present Value (NPV) of The Executive's Role in Social Business

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 Social Initiatives 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 Social Initiatives 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	(10003242)	-10003242	-	-
Year 1	3472960	-6530282	3472960	0.8696	3019965
Year 2	3978956	-2551326	7451916	0.7561	3008662
Year 3	3965147	1413821	11417063	0.6575	2607149
Year 4	3241663	4655484	14658726	0.5718	1853431
TOTAL					10489207

The Net NPV after 4 years is 485965

(10489207 - 10003242 )

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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	(10003242)	-10003242	-	-
Year 1	3472960	-6530282	3472960	0.8333	2894133
Year 2	3978956	-2551326	7451916	0.6944	2763164
Year 3	3965147	1413821	11417063	0.5787	2294645
Year 4	3241663	4655484	14658726	0.4823	1563302
TOTAL					9515244

The Net NPV after 4 years is -487998

At 20% discount rate the NPV is negative (9515244 - 10003242 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Social Initiatives 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 Social Initiatives has a NPV value higher than Zero then finance managers at Social Initiatives 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 Social Initiatives, then the stock price of the Social Initiatives 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 Social Initiatives 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 can impact the cash flow of the project.

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.

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 The Executive's Role in Social Business

References & Further Readings

David Kiron, Douglas Palmer, Anh Nguyen Phillips, Robert Berkman (2018), "The Executive's Role in Social Business Harvard Business Review Case Study. Published by HBR Publications.