Ions Consulting: The MP 2 Training Program 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 Ions Consulting: The MP 2 Training Program case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Ions Consulting: The MP 2 Training Program case study is a Harvard Business School (HBR) case study written by June Cotte, Seung Hwan (Mark) Lee. The Ions Consulting: The MP 2 Training Program (referred as “Mp Program” 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, Change management, Developing employees, Employee retention.

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 Ions Consulting: The MP 2 Training Program Case Study

This is part of the subset of Ivey cases and technical notes written for Introductory-Level courses.The recently hired human resources (HR) director had to come up with a program that would meet the needs of transferring knowledge from older, more experienced project consultants to the junior and newly hired inexperienced associates. The HR director designed a program called the Mentoring Management Project for Professionals (MP 2). The program met with great resistance from all levels of the organization, which made the development and the implementation process more difficult. The MP 2 program was implemented on a trial basis and after four months, due to mixed results, the HR director was more confused than ever. He had three days left to prove to the executive board that the program is worth the cost, the time and the resources to implement.

Case Authors : June Cotte, Seung Hwan (Mark) Lee

Topic : Leadership & Managing People

Related Areas : Change management, Developing employees, Employee retention

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Calculating Net Present Value (NPV) at 6% for Ions Consulting: The MP 2 Training Program Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10015210)	-10015210	-	-
Year 1	3449022	-6566188	3449022	0.9434	3253794
Year 2	3955681	-2610507	7404703	0.89	3520542
Year 3	3952526	1342019	11357229	0.8396	3318617
Year 4	3223131	4565150	14580360	0.7921	2553022
TOTAL			14580360		12645975

The Net Present Value at 6% discount rate is 2630765

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. Payback Period
2. Net Present Value
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. Timing of the expected cash flows – stockholders of Mp Program 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. Mp Program 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 Ions Consulting: The MP 2 Training Program

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 Mp Program 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 Mp Program 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	(10015210)	-10015210	-	-
Year 1	3449022	-6566188	3449022	0.8696	2999150
Year 2	3955681	-2610507	7404703	0.7561	2991063
Year 3	3952526	1342019	11357229	0.6575	2598850
Year 4	3223131	4565150	14580360	0.5718	1842836
TOTAL					10431898

The Net NPV after 4 years is 416688

(10431898 - 10015210 )

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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	(10015210)	-10015210	-	-
Year 1	3449022	-6566188	3449022	0.8333	2874185
Year 2	3955681	-2610507	7404703	0.6944	2747001
Year 3	3952526	1342019	11357229	0.5787	2287341
Year 4	3223131	4565150	14580360	0.4823	1554365
TOTAL					9462892

The Net NPV after 4 years is -552318

At 20% discount rate the NPV is negative (9462892 - 10015210 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Mp Program 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 Mp Program has a NPV value higher than Zero then finance managers at Mp Program 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 Mp Program, then the stock price of the Mp Program 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 Mp Program 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 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.

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 Ions Consulting: The MP 2 Training Program

References & Further Readings

June Cotte, Seung Hwan (Mark) Lee (2018), "Ions Consulting: The MP 2 Training Program Harvard Business Review Case Study. Published by HBR Publications.