What to Expect From a Corporate Lean Program 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 What to Expect From a Corporate Lean Program case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. What to Expect From a Corporate Lean Program case study is a Harvard Business School (HBR) case study written by Torbjorn Netland, Kasra Ferdows. The What to Expect From a Corporate Lean Program (referred as “Production Volvo” 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 What to Expect From a Corporate Lean Program Case Study

Corporate "lean" programs, often modeled after the Toyota Production System, can be powerful instruments for improving the performance of manufacturing plants. They help to emphasize parts of the production process that add the most value and eliminate those that don't. However, misplaced expectations can make implementation difficult and reduce the benefits. The authors argue that if managers better understood the expected rates of improvement, then implementations would go more smoothly. The authors studied the implementation of the Volvo Group's production system. Volvo Group, a leading maker of trucks and other heavy vehicles. The company introduced the Volvo Production System in 2007, and since then has been implementing it in its factories around the world. The authors visited 44 of Volvo's 67 plants and interviewed 200 managers. They found that there were four distinct stages of change in the rate of performance improvement and that there was a strong relationship between a plant's maturity in a production system implementation and its performance; progress roughly followed the shape of an S-curve: a plant's rate of improvement changes in the shape of a bell curve as the plant becomes more mature in implementing the production system. Performance improves slowly at first, and then at an increasing rate before the improvement rate gradually decreases. To measure the performance of the plants, the authors focused on nonfinancial metrics related to the quality, cost, delivery and safety of the plant's output. They then used statistical methods to find patterns. Volvo's assessment process provides a structure to help local managers compare their plants. It also provides a mechanism for transferring expertise and best practices. The assessments have a strong symbolic impact: They communicate the company's commitment to the production system. Implementing a production system is a long journey, but the authors conclude that it's a worthwhile endeavor. This is an MIT Sloan Management Review article.

Case Authors : Torbjorn Netland, Kasra Ferdows

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for What to Expect From a Corporate Lean Program Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012529)	-10012529	-	-
Year 1	3445353	-6567176	3445353	0.9434	3250333
Year 2	3954517	-2612659	7399870	0.89	3519506
Year 3	3960043	1347384	11359913	0.8396	3324928
Year 4	3228573	4575957	14588486	0.7921	2557332
TOTAL			14588486		12652100

The Net Present Value at 6% discount rate is 2639571

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. 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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Production Volvo 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 Production Volvo 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 What to Expect From a Corporate Lean Program

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 Production Volvo 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 Production Volvo 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	(10012529)	-10012529	-	-
Year 1	3445353	-6567176	3445353	0.8696	2995959
Year 2	3954517	-2612659	7399870	0.7561	2990183
Year 3	3960043	1347384	11359913	0.6575	2603793
Year 4	3228573	4575957	14588486	0.5718	1845947
TOTAL					10435882

The Net NPV after 4 years is 423353

(10435882 - 10012529 )

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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	(10012529)	-10012529	-	-
Year 1	3445353	-6567176	3445353	0.8333	2871128
Year 2	3954517	-2612659	7399870	0.6944	2746192
Year 3	3960043	1347384	11359913	0.5787	2291692
Year 4	3228573	4575957	14588486	0.4823	1556989
TOTAL					9466001

The Net NPV after 4 years is -546528

At 20% discount rate the NPV is negative (9466001 - 10012529 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Production Volvo 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 Production Volvo has a NPV value higher than Zero then finance managers at Production Volvo 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 Production Volvo, then the stock price of the Production Volvo 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 Production Volvo 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.

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.

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 What to Expect From a Corporate Lean Program

References & Further Readings

Torbjorn Netland, Kasra Ferdows (2018), "What to Expect From a Corporate Lean Program Harvard Business Review Case Study. Published by HBR Publications.