Radial Bearing Team: A Manufacturing Group's Transformation to Self-Directed Work Teams 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 Radial Bearing Team: A Manufacturing Group's Transformation to Self-Directed Work Teams case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Radial Bearing Team: A Manufacturing Group's Transformation to Self-Directed Work Teams case study is a Harvard Business School (HBR) case study written by Sean Wirth, Joseph K Kavanaugh, Victor Sower. The Radial Bearing Team: A Manufacturing Group's Transformation to Self-Directed Work Teams (referred as “Directed Sdwt” 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, Leadership, Organizational structure, Product development.

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 Radial Bearing Team: A Manufacturing Group's Transformation to Self-Directed Work Teams Case Study

This case focuses on a major manufacturing division ($1.2 billion sales; 5500 employees) of a global oilfield services company as it converts from a departmental organization with a "traditional" machine shop hierarchy to a team-based environment. During the conversion, roles and responsibilities change from a traditional foreman structure to a Self-Directed Work Team (SDWT) structure for the Radial Bearing Team. Individual behaviors and the dynamics of change influence how the team copes with new responsibilities, authority and problem solving as together, they manage equipment utilization and the day-to-day workflow, and control quality. Some dysfunction arises as the leaders of this organization manage the change process while trying to support the new roles and ideas. The team is successful, but everyone has to encourage innovation while adapting to the changing environment. The case also highlights specific techniques the team adopts for monitoring its performance as it assumes responsibility and accountability for quality improvement. Management had challenged the unit's leadership to produce results that justified the implementation of Self-Directed Work Teams (SDWTs). Now, George Smiley, the machine shop manager, and Shane Husky, the internal OD specialist, had to present evidence to help management decide if expansion of the SDWT program was warranted and the best practices learned from the RBT experience that would contribute to future success.

Case Authors : Sean Wirth, Joseph K Kavanaugh, Victor Sower

Topic : Leadership & Managing People

Related Areas : Leadership, Organizational structure, Product development

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Calculating Net Present Value (NPV) at 6% for Radial Bearing Team: A Manufacturing Group's Transformation to Self-Directed Work Teams Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10025111)	-10025111	-	-
Year 1	3447323	-6577788	3447323	0.9434	3252192
Year 2	3967035	-2610753	7414358	0.89	3530647
Year 3	3939403	1328650	11353761	0.8396	3307599
Year 4	3238880	4567530	14592641	0.7921	2565496
TOTAL			14592641		12655934

The Net Present Value at 6% discount rate is 2630823

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. Timing of the expected cash flows – stockholders of Directed Sdwt 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. Directed Sdwt 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 Radial Bearing Team: A Manufacturing Group's Transformation to Self-Directed Work Teams

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 Directed Sdwt 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 Directed Sdwt 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	(10025111)	-10025111	-	-
Year 1	3447323	-6577788	3447323	0.8696	2997672
Year 2	3967035	-2610753	7414358	0.7561	2999648
Year 3	3939403	1328650	11353761	0.6575	2590221
Year 4	3238880	4567530	14592641	0.5718	1851840
TOTAL					10439382

The Net NPV after 4 years is 414271

(10439382 - 10025111 )

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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	(10025111)	-10025111	-	-
Year 1	3447323	-6577788	3447323	0.8333	2872769
Year 2	3967035	-2610753	7414358	0.6944	2754885
Year 3	3939403	1328650	11353761	0.5787	2279747
Year 4	3238880	4567530	14592641	0.4823	1561960
TOTAL					9469362

The Net NPV after 4 years is -555749

At 20% discount rate the NPV is negative (9469362 - 10025111 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Directed Sdwt 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 Directed Sdwt has a NPV value higher than Zero then finance managers at Directed Sdwt 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 Directed Sdwt, then the stock price of the Directed Sdwt 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 Directed Sdwt 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.

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 will be a multi year spillover effect of various taxation regulations.

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 Radial Bearing Team: A Manufacturing Group's Transformation to Self-Directed Work Teams

References & Further Readings

Sean Wirth, Joseph K Kavanaugh, Victor Sower (2018), "Radial Bearing Team: A Manufacturing Group's Transformation to Self-Directed Work Teams Harvard Business Review Case Study. Published by HBR Publications.