What Successful Project Managers Do 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 Successful Project Managers Do case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. What Successful Project Managers Do case study is a Harvard Business School (HBR) case study written by Alexander Laufer, Edward J. Hoffman, Jeffrey S. Russell, W. Scott Cameron. The What Successful Project Managers Do (referred as “Project Events” 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 Successful Project Managers Do Case Study

This is an MIT Sloan Management Review article. In today's dynamic and competitive world, a project manager's key challenge is coping with frequent unexpected events. Such events can be classified according to their level of predictability as follows: events that were anticipated but whose impacts were much stronger than expected; events that could not have been predicted; and events that could have been predicted but were not. Coping with frequent unexpected events requires an organizational culture that allows the project manager to exercise a great amount of flexibility. The traditional approach to project management emphasizes that project success depends on stability. According to this approach, project success can be achieved by focusing on planning and on controlling and managing risks. Although the popularity of this approach has sharply increased across industries, research covering a wide variety of projects consistently reveals poor performance. The authors collected data from more than 150 successful project managers affiliated with more than 20 organizations and concluded that today's successful project managers cope with unexpected events by a combination of traditional and "agile"approaches to project management. Using business examples drawn from their research at organizations such as Procter & Gamble, NASA and the construction services company Boldt, the authors identified four key roles that successful project managers play: a??The first role, developing collaboration, is performed early on during the project. a??The second role, integrating planning and review with learning, is performed periodically throughout the project. a??The third role, preventing major disruptions, is performed occasionally. a??The fourth role, maintaining forward momentum, is performed continuously. Today's managers must be people-oriented, information-oriented and action-oriented. The authors argue that by assuming the four roles discussed in this article, successful project managers will embrace all three orientations.

Case Authors : Alexander Laufer, Edward J. Hoffman, Jeffrey S. Russell, W. Scott Cameron

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for What Successful Project Managers Do Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012936)	-10012936	-	-
Year 1	3470795	-6542141	3470795	0.9434	3274335
Year 2	3978684	-2563457	7449479	0.89	3541015
Year 3	3972638	1409181	11422117	0.8396	3335503
Year 4	3232930	4642111	14655047	0.7921	2560783
TOTAL			14655047		12711636

The Net Present Value at 6% discount rate is 2698700

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. Payback Period
4. Net Present Value

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. Project Events 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 Project Events 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 Successful Project Managers Do

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 Project Events 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 Project Events 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	(10012936)	-10012936	-	-
Year 1	3470795	-6542141	3470795	0.8696	3018083
Year 2	3978684	-2563457	7449479	0.7561	3008457
Year 3	3972638	1409181	11422117	0.6575	2612074
Year 4	3232930	4642111	14655047	0.5718	1848438
TOTAL					10487052

The Net NPV after 4 years is 474116

(10487052 - 10012936 )

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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	(10012936)	-10012936	-	-
Year 1	3470795	-6542141	3470795	0.8333	2892329
Year 2	3978684	-2563457	7449479	0.6944	2762975
Year 3	3972638	1409181	11422117	0.5787	2298980
Year 4	3232930	4642111	14655047	0.4823	1559090
TOTAL					9513375

The Net NPV after 4 years is -499561

At 20% discount rate the NPV is negative (9513375 - 10012936 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Project Events 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 Project Events has a NPV value higher than Zero then finance managers at Project Events 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 Project Events, then the stock price of the Project Events 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 Project Events 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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

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.

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Negotiation Strategy of What Successful Project Managers Do

References & Further Readings

Alexander Laufer, Edward J. Hoffman, Jeffrey S. Russell, W. Scott Cameron (2018), "What Successful Project Managers Do Harvard Business Review Case Study. Published by HBR Publications.