Knowledge Management at the World Bank: Part 2 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 Knowledge Management at the World Bank: Part 2 case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Knowledge Management at the World Bank: Part 2 case study is a Harvard Business School (HBR) case study written by Don Oppenheimer, Laurence Prusak. The Knowledge Management at the World Bank: Part 2 (referred as “Knowledge Bank” 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, Decision making, Knowledge management, Leadership.

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 Knowledge Management at the World Bank: Part 2 Case Study

This case is about how the World Bank, after determining that the creation and dissemination of knowledge to the international development community was one of their strategic roles and objectives, transitioned from being just a lending bank to both a lending and "knowledge bank." The challenges and issues addressed in this case are focused around both general change management issues (aligning the organization around a totally different set of goals and priorities) and specific knowledge management challenges (incentives to share knowledge; institutionalizing KM in the daily roles and activities of employees; defining metrics to measure success and impact). This is a follow-up, "part 2" to an earlier case published by the Harvard Kennedy School (case number 1936.0, "Knowledge Management at the World Bank"), which focused on the thirteen-year period that the Bank management internally promoted the idea that the Bank needed to become the leading creator, broker and sharer of knowledge about international development. As a result of this thirteen-year effort, by 2009 there was a fair amount of acceptance and support within the Bank for the new knowledge management objectives, and this case is more focused on how the Bank approached achieving their knowledge management-related goals and overcoming the associated internal transformational challenges. Case number 2012.0.

Case Authors : Don Oppenheimer, Laurence Prusak

Topic : Leadership & Managing People

Related Areas : Decision making, Knowledge management, Leadership

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Calculating Net Present Value (NPV) at 6% for Knowledge Management at the World Bank: Part 2 Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10005727)	-10005727	-	-
Year 1	3449319	-6556408	3449319	0.9434	3254075
Year 2	3963938	-2592470	7413257	0.89	3527891
Year 3	3946952	1354482	11360209	0.8396	3313937
Year 4	3239467	4593949	14599676	0.7921	2565961
TOTAL			14599676		12661864

The Net Present Value at 6% discount rate is 2656137

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

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. Knowledge Bank 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 Knowledge Bank 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 Knowledge Management at the World Bank: Part 2

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 Knowledge Bank 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 Knowledge Bank 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	(10005727)	-10005727	-	-
Year 1	3449319	-6556408	3449319	0.8696	2999408
Year 2	3963938	-2592470	7413257	0.7561	2997307
Year 3	3946952	1354482	11360209	0.6575	2595185
Year 4	3239467	4593949	14599676	0.5718	1852176
TOTAL					10444075

The Net NPV after 4 years is 438348

(10444075 - 10005727 )

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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	(10005727)	-10005727	-	-
Year 1	3449319	-6556408	3449319	0.8333	2874433
Year 2	3963938	-2592470	7413257	0.6944	2752735
Year 3	3946952	1354482	11360209	0.5787	2284116
Year 4	3239467	4593949	14599676	0.4823	1562243
TOTAL					9473526

The Net NPV after 4 years is -532201

At 20% discount rate the NPV is negative (9473526 - 10005727 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Knowledge Bank 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 Knowledge Bank has a NPV value higher than Zero then finance managers at Knowledge Bank 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 Knowledge Bank, then the stock price of the Knowledge Bank 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 Knowledge Bank 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.

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

Understanding of risks involved in the project.

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 Knowledge Management at the World Bank: Part 2

References & Further Readings

Don Oppenheimer, Laurence Prusak (2018), "Knowledge Management at the World Bank: Part 2 Harvard Business Review Case Study. Published by HBR Publications.