Health Leads (A): Expansion Decisions for a Health Care Nonprofit 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 Health Leads (A): Expansion Decisions for a Health Care Nonprofit case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Health Leads (A): Expansion Decisions for a Health Care Nonprofit case study is a Harvard Business School (HBR) case study written by Jesper Sorensen, Debra Schifrin, Kevin Hettrich. The Health Leads (A): Expansion Decisions for a Health Care Nonprofit (referred as “Leads Health” 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 Health Leads (A): Expansion Decisions for a Health Care Nonprofit Case Study

The (A) case presents a 2009 critical expansion decision for health care nonprofit Health Leads: whether to expand rapidly while it had momentum, strong advocates, very high demand for its services, and funder support for growth; or whether to postpone rapid expansion and continue working on its model and further prove the company's value to hospitals and clinics. Founded by Rebecca Onie (2009 MacArthur "Genius Grant" Fellow), Health Leads addressed issues at the intersection of health and poverty. The organization operated "Help Desks" in hospitals and clinics to connect patients to essential non-medical resources that could improve their health, such as adequate food, heating, and housing. College student volunteers ran Health Leads' desks, and in 2008 the company helped over 4,000 patients through 20 desks in six U.S. cities. The factors that Health Leads considered in making its expansion decision included: its role as a mission-based nonprofit and its desire to make a national impact; the extremely high demand for new Health Leads Help Desks (up to 500 requests a year); funder growth expectations; concerns about diluting the culture and the brand; and the need for more data to prove the company's financial value to hospitals and clinics. Health Leads also had to decide what expansion would look like if it decided to take that path. Would it mean adding desks in cities in which it already operated or expanding to new cities? If Health Leads expanded, how quickly should it do so? The (B) case describes the company's strategic decision and its impact, and presents the status of Health Leads in the summer of 2013.

Case Authors : Jesper Sorensen, Debra Schifrin, Kevin Hettrich

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Health Leads (A): Expansion Decisions for a Health Care Nonprofit Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016384)	-10016384	-	-
Year 1	3446112	-6570272	3446112	0.9434	3251049
Year 2	3963785	-2606487	7409897	0.89	3527755
Year 3	3947497	1341010	11357394	0.8396	3314395
Year 4	3242790	4583800	14600184	0.7921	2568593
TOTAL			14600184		12661792

The Net Present Value at 6% discount rate is 2645408

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

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. Leads Health 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 Leads Health 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 Health Leads (A): Expansion Decisions for a Health Care Nonprofit

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 Leads Health 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 Leads Health 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	(10016384)	-10016384	-	-
Year 1	3446112	-6570272	3446112	0.8696	2996619
Year 2	3963785	-2606487	7409897	0.7561	2997191
Year 3	3947497	1341010	11357394	0.6575	2595543
Year 4	3242790	4583800	14600184	0.5718	1854076
TOTAL					10443429

The Net NPV after 4 years is 427045

(10443429 - 10016384 )

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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	(10016384)	-10016384	-	-
Year 1	3446112	-6570272	3446112	0.8333	2871760
Year 2	3963785	-2606487	7409897	0.6944	2752628
Year 3	3947497	1341010	11357394	0.5787	2284431
Year 4	3242790	4583800	14600184	0.4823	1563845
TOTAL					9472665

The Net NPV after 4 years is -543719

At 20% discount rate the NPV is negative (9472665 - 10016384 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Leads Health 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 Leads Health has a NPV value higher than Zero then finance managers at Leads Health 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 Leads Health, then the stock price of the Leads Health 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 Leads Health 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 uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

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.

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 Health Leads (A): Expansion Decisions for a Health Care Nonprofit

References & Further Readings

Jesper Sorensen, Debra Schifrin, Kevin Hettrich (2018), "Health Leads (A): Expansion Decisions for a Health Care Nonprofit Harvard Business Review Case Study. Published by HBR Publications.