REVIEWING STRATEGY-EXECUTION CAPABILITIES 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 REVIEWING STRATEGY-EXECUTION CAPABILITIES case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. REVIEWING STRATEGY-EXECUTION CAPABILITIES case study is a Harvard Business School (HBR) case study written by Xavier Gilbert. The REVIEWING STRATEGY-EXECUTION CAPABILITIES (referred as “Execution Capabilities” 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, .

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 REVIEWING STRATEGY-EXECUTION CAPABILITIES Case Study

This note is a self-assessment instrument to help identify whether an organization has the required capabilities to successfully execute its strategic initiatives. It is meant to be used to support the group work of a group of executives (preferably from the same company) who are responsible for the execution of one or several strategic initiatives in their organization.A "radar chart" is proposed to visualize where the company needs to improve. It can also be used to support the discussion of any group of executives on the reasons for failure of most strategic initiatives; they may do that by assessing their own company against the six proposed required capabilities and by comparing notes with each other. The six required capabilities are: 1) Companies need to have a clear and well-communicated strategy, with clear and well-communicated strategic priorities, to which strategic initiatives contribute in a clear and well-communicated way. 2) Companies need to have a cadre of executives at different levels selected for their entrepreneurial and action-learning capabilities. 3) Companies need to understand and encourage action-learning and know how to plan execution accordingly. 4) Companies need to have an inclusive approach to execution. 5) Companies need to be serious about follow-through and see it as an essential part of action-learning. 6) Companies need to realize that, in the end, lack of respect for people, is a sure cause for execution failure. These capabilities are described at length in the book Smarter Execution, published by IMD (also available from Amazon UK). Learning objectives: This note is very effective to support a group discussion on the execution capabilities of a company. It can be used by a senior management team before they decide to launch strategic initiatives; it can be used as part of a kick-off workshop when launching a strategic initiative; or it can be used along the way during execution to identify and correct execution frustrations.

Case Authors : Xavier Gilbert

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for REVIEWING STRATEGY-EXECUTION CAPABILITIES Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10011542)	-10011542	-	-
Year 1	3453035	-6558507	3453035	0.9434	3257580
Year 2	3973513	-2584994	7426548	0.89	3536412
Year 3	3966883	1381889	11393431	0.8396	3330671
Year 4	3240441	4622330	14633872	0.7921	2566733
TOTAL			14633872		12691397

The Net Present Value at 6% discount rate is 2679855

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. Profitability Index
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. Timing of the expected cash flows – stockholders of Execution Capabilities 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. Execution Capabilities 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 REVIEWING STRATEGY-EXECUTION CAPABILITIES

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 Execution Capabilities 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 Execution Capabilities 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	(10011542)	-10011542	-	-
Year 1	3453035	-6558507	3453035	0.8696	3002639
Year 2	3973513	-2584994	7426548	0.7561	3004547
Year 3	3966883	1381889	11393431	0.6575	2608290
Year 4	3240441	4622330	14633872	0.5718	1852733
TOTAL					10468208

The Net NPV after 4 years is 456666

(10468208 - 10011542 )

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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	(10011542)	-10011542	-	-
Year 1	3453035	-6558507	3453035	0.8333	2877529
Year 2	3973513	-2584994	7426548	0.6944	2759384
Year 3	3966883	1381889	11393431	0.5787	2295650
Year 4	3240441	4622330	14633872	0.4823	1562713
TOTAL					9495276

The Net NPV after 4 years is -516266

At 20% discount rate the NPV is negative (9495276 - 10011542 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Execution Capabilities 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 Execution Capabilities has a NPV value higher than Zero then finance managers at Execution Capabilities 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 Execution Capabilities, then the stock price of the Execution Capabilities 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 Execution Capabilities 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 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 can impact the cash flow of the project.

Understanding of risks involved in 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 REVIEWING STRATEGY-EXECUTION CAPABILITIES

References & Further Readings

Xavier Gilbert (2018), "REVIEWING STRATEGY-EXECUTION CAPABILITIES Harvard Business Review Case Study. Published by HBR Publications.