Paula Evans and the Redesign of the Cambridge Rindge and Latin School (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 Paula Evans and the Redesign of the Cambridge Rindge and Latin School (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Paula Evans and the Redesign of the Cambridge Rindge and Latin School (A) case study is a Harvard Business School (HBR) case study written by Linda A. Hill, Kristin C. Doughty, Ellen Pruyne. The Paula Evans and the Redesign of the Cambridge Rindge and Latin School (A) (referred as “Evans School” 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, Gender, Leadership, Reorganization.

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 Paula Evans and the Redesign of the Cambridge Rindge and Latin School (A) Case Study

Paula Evans is in her second year as principal of the only high school in Cambridge, MA. Her mandate when she arrived was to redesign the high school so that long-standing inequities in academic achievement rates across race and socioeconomic class were removed. In her first year, she succeeded in obtaining approval for her proposed redesign and completing the physical and administrative restructuring of the high school. Now in her second year, the reforms in how teachers teach and how the school operates are fully under way. From early indications, she and her hand-picked leadership team are moving the school in the desired direction. But the school committee has just made a policy decision that Evans and her team believe will undo all of the redesign efforts that have been made thus far. Evans has threatened to resign and now ponders what she will tell her leadership team and the faculty the next day.

Case Authors : Linda A. Hill, Kristin C. Doughty, Ellen Pruyne

Topic : Leadership & Managing People

Related Areas : Gender, Leadership, Reorganization

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Calculating Net Present Value (NPV) at 6% for Paula Evans and the Redesign of the Cambridge Rindge and Latin School (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10027495)	-10027495	-	-
Year 1	3465086	-6562409	3465086	0.9434	3268949
Year 2	3967235	-2595174	7432321	0.89	3530825
Year 3	3960800	1365626	11393121	0.8396	3325564
Year 4	3227683	4593309	14620804	0.7921	2556627
TOTAL			14620804		12681965

The Net Present Value at 6% discount rate is 2654470

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. Net Present Value
2. Profitability Index
3. Payback Period
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. Timing of the expected cash flows – stockholders of Evans School 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. Evans School 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 Paula Evans and the Redesign of the Cambridge Rindge and Latin School (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 Evans School 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 Evans School 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	(10027495)	-10027495	-	-
Year 1	3465086	-6562409	3465086	0.8696	3013118
Year 2	3967235	-2595174	7432321	0.7561	2999800
Year 3	3960800	1365626	11393121	0.6575	2604290
Year 4	3227683	4593309	14620804	0.5718	1845438
TOTAL					10462646

The Net NPV after 4 years is 435151

(10462646 - 10027495 )

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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	(10027495)	-10027495	-	-
Year 1	3465086	-6562409	3465086	0.8333	2887572
Year 2	3967235	-2595174	7432321	0.6944	2755024
Year 3	3960800	1365626	11393121	0.5787	2292130
Year 4	3227683	4593309	14620804	0.4823	1556560
TOTAL					9491286

The Net NPV after 4 years is -536209

At 20% discount rate the NPV is negative (9491286 - 10027495 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Evans School 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 Evans School has a NPV value higher than Zero then finance managers at Evans School 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 Evans School, then the stock price of the Evans School 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 Evans School 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.

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 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.

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 Paula Evans and the Redesign of the Cambridge Rindge and Latin School (A)

References & Further Readings

Linda A. Hill, Kristin C. Doughty, Ellen Pruyne (2018), "Paula Evans and the Redesign of the Cambridge Rindge and Latin School (A) Harvard Business Review Case Study. Published by HBR Publications.