Discrimination or Non-Performance? 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 Discrimination or Non-Performance? case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Discrimination or Non-Performance? case study is a Harvard Business School (HBR) case study written by Carol J Cumber, Jamie O'Brien. The Discrimination or Non-Performance? (referred as “Npu Annan” 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

Case Description of Discrimination or Non-Performance? Case Study

Dr. George Annan was hired as an assistant professor at Northern Plains University (NPU) in August of 2003. He was born in Kenya, Africa, and was of African descent. NPU was a predominantly white institution, and he joined a small department with faculty consisting of three additional men and one woman - all white, and with varying ranks from instructor to associate professor. Although initially evaluated as having achieved the level of performance "reasonably expected in an Assistant Professor," subsequent evaluations were increasingly negative, and he was informed that his performance did not meet the expectations required of faculty at NPU. His contract was terminated at the end of his second year. Department Head Mary Reed believed that she had provided adequate feedback and support so that this outcome could have been avoided - if he had listened to her. Annan contended that he was treated unfairly by being assigned introductory level classes that wasted his talents as a Ph.D., and because he was an African man surrounded by a predominantly white faculty and student body. He was threatening to sue NPU for discrimination. Although Department Head Reed felt that Annan had largely ignored her advice on how to improve his performance, she knew that she needed to prepare evidence to defend NPU in case Annan decided to pursue legal action. Her primary concern was that Annan would allege discrimination under Title VII of the Civil Rights Act of 1964, claiming he was discriminated against on the basis of race.

Case Authors : Carol J Cumber, Jamie O'Brien

Topic : Leadership & Managing People

Related Areas :

Calculating Net Present Value (NPV) at 6% for Discrimination or Non-Performance? Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10013120) -10013120 - -
Year 1 3462587 -6550533 3462587 0.9434 3266592
Year 2 3982607 -2567926 7445194 0.89 3544506
Year 3 3963153 1395227 11408347 0.8396 3327540
Year 4 3226676 4621903 14635023 0.7921 2555830
TOTAL 14635023 12694467

The Net Present Value at 6% discount rate is 2681347

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. Net Present Value
2. Payback Period
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Npu Annan 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 Npu Annan have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

Formula and Steps to Calculate Net Present Value (NPV) of Discrimination or Non-Performance?

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 Npu Annan 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 Npu Annan 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 %
Cash Flows
Year 0 (10013120) -10013120 - -
Year 1 3462587 -6550533 3462587 0.8696 3010945
Year 2 3982607 -2567926 7445194 0.7561 3011423
Year 3 3963153 1395227 11408347 0.6575 2605837
Year 4 3226676 4621903 14635023 0.5718 1844862
TOTAL 10473068

The Net NPV after 4 years is 459948

(10473068 - 10013120 )

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 %
Cash Flows
Year 0 (10013120) -10013120 - -
Year 1 3462587 -6550533 3462587 0.8333 2885489
Year 2 3982607 -2567926 7445194 0.6944 2765699
Year 3 3963153 1395227 11408347 0.5787 2293491
Year 4 3226676 4621903 14635023 0.4823 1556074
TOTAL 9500754

The Net NPV after 4 years is -512366

At 20% discount rate the NPV is negative (9500754 - 10013120 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Npu Annan 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 Npu Annan has a NPV value higher than Zero then finance managers at Npu Annan 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 Npu Annan, then the stock price of the Npu Annan 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 Npu Annan 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 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.

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

Carol J Cumber, Jamie O'Brien (2018), "Discrimination or Non-Performance? Harvard Business Review Case Study. Published by HBR Publications.