Standards for Child Sponsorship Agencies (A) 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 Standards for Child Sponsorship Agencies (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Standards for Child Sponsorship Agencies (A) case study is a Harvard Business School (HBR) case study written by Esther Scott, David Brown. The Standards for Child Sponsorship Agencies (A) (referred as “Agencies Child” 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, Emerging markets, Human resource management, Marketing, Organizational culture, Project management, Social enterprise, Strategic planning.

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 Standards for Child Sponsorship Agencies (A) Case Study

In the spring of 1998, nonprofit agencies known as "child-sponsorship" organizations found themselves on the defensive. The agencies-dedicated to raising charitable funds in the United States to support children and their communities in poor, developing countries-had been the subject of a scathing critique, a two-part series in the Chicago Tribune accusing them, in effect, of misleading donors. The series asserted that the organizations had not lived up to the promise implicit in fundraising advertisements: that specific children would benefit directly from the contributions of individual sponsors. The agencies mounted a spirited and largely successful public defense of their approach-one in which aid was targeted not only at individual children but at the communities in which they lived. At the same time, however, they sought new ways to reassure the public about their effectiveness. This case details the ensuing effort by a group of six child sponsorship agencies to agree on "industry" standards that would make their goals and methods clear. The case describes the differing situations of the various organizations so as to lay the groundwork for discussion about likely difficulties in reaching agreement on standards, as well as extrapolation as to what sort of standards could both command consensus among the agencies and satisfy public demands for "transparency." The case serves the broader purpose of framing the issues and dynamics of industry self-regulation more generally, particularly in a nonprofit context. See also, Part B (1665.0). HKS Case Number 1664.0

Case Authors : Esther Scott, David Brown

Topic : Leadership & Managing People

Related Areas : Emerging markets, Human resource management, Marketing, Organizational culture, Project management, Social enterprise, Strategic planning

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Calculating Net Present Value (NPV) at 6% for Standards for Child Sponsorship Agencies (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10015403)	-10015403	-	-
Year 1	3463886	-6551517	3463886	0.9434	3267817
Year 2	3976740	-2574777	7440626	0.89	3539284
Year 3	3942413	1367636	11383039	0.8396	3310126
Year 4	3227224	4594860	14610263	0.7921	2556264
TOTAL			14610263		12673491

The Net Present Value at 6% discount rate is 2658088

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. Internal Rate of Return
3. Net Present Value
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Agencies Child 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 Agencies Child 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 Standards for Child Sponsorship Agencies (A)

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 Agencies Child 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 Agencies Child 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	(10015403)	-10015403	-	-
Year 1	3463886	-6551517	3463886	0.8696	3012075
Year 2	3976740	-2574777	7440626	0.7561	3006987
Year 3	3942413	1367636	11383039	0.6575	2592201
Year 4	3227224	4594860	14610263	0.5718	1845176
TOTAL					10456438

The Net NPV after 4 years is 441035

(10456438 - 10015403 )

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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	(10015403)	-10015403	-	-
Year 1	3463886	-6551517	3463886	0.8333	2886572
Year 2	3976740	-2574777	7440626	0.6944	2761625
Year 3	3942413	1367636	11383039	0.5787	2281489
Year 4	3227224	4594860	14610263	0.4823	1556339
TOTAL					9486024

The Net NPV after 4 years is -529379

At 20% discount rate the NPV is negative (9486024 - 10015403 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Agencies Child 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 Agencies Child has a NPV value higher than Zero then finance managers at Agencies Child 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 Agencies Child, then the stock price of the Agencies Child 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 Agencies Child 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.

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.

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 Standards for Child Sponsorship Agencies (A)

References & Further Readings

Esther Scott, David Brown (2018), "Standards for Child Sponsorship Agencies (A) Harvard Business Review Case Study. Published by HBR Publications.