Coastal Ventures Limited Partnership: Balancing a Sustainable Investment Strategy with a Social Mission 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 Coastal Ventures Limited Partnership: Balancing a Sustainable Investment Strategy with a Social Mission case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Coastal Ventures Limited Partnership: Balancing a Sustainable Investment Strategy with a Social Mission case study is a Harvard Business School (HBR) case study written by Guy Stuart. The Coastal Ventures Limited Partnership: Balancing a Sustainable Investment Strategy with a Social Mission (referred as “Fund Coastal” 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, Financial management, Human resource management, International business, Leadership, Strategic planning, Sustainability.

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 Coastal Ventures Limited Partnership: Balancing a Sustainable Investment Strategy with a Social Mission Case Study

Nat Henshaw, president of CEI Ventures Inc. (CVI) a subsidiary of the nonprofit Coastal Enterprises Inc. (CEI), was involved in a balancing act. He was a manager of a for-profit venture capital fund, Coastal Ventures Limited Partnership (CVLP), with a social mission that valued good-quality jobs, employee ownership, and a concern for the environment. Henshaw and his board of directors were also thinking about the next venture capital fund, which they wanted to have in place when they began to wind down the investment activity of the current fund. Did they have the right balance between profit and social mission? Could they invest the remaining 60% of CVLP's funds in the next two years in a manner that struck the right balance? And did they have a good enough track record to attract investment into a new fund? Many students will be unfamiliar with this type of institution and the case provides sufficient details on the institutional structure of a community development venture capital fund and the way it operates to serve as an introduction to this subject. It demonstrates the way in which both institutionally and operationally the fund is designed to promote both profitable investments and a social mission. Nevertheless, the fund faces considerable problems in maintaining this balance. The case can then serve as a platform for a discussion of the effectiveness of such an institution in promoting community economic development. More generally, this case can be used to teach students about the "double bottom-line," where the bottom line is of a business which is the subsidiary of a nonprofit institution, which set up the business in the first place as part of its efforts to fulfill its mission. Such arrangements are becoming more common in the US nonprofit sector and they raise issues about the legitimacy of for-profit subsidiaries and the blurring of the line between the for-profit and nonprofit world. HKS Case Number 1669.0

Case Authors : Guy Stuart

Topic : Leadership & Managing People

Related Areas : Financial management, Human resource management, International business, Leadership, Strategic planning, Sustainability

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Calculating Net Present Value (NPV) at 6% for Coastal Ventures Limited Partnership: Balancing a Sustainable Investment Strategy with a Social Mission Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10009901)	-10009901	-	-
Year 1	3453327	-6556574	3453327	0.9434	3257856
Year 2	3969758	-2586816	7423085	0.89	3533070
Year 3	3974584	1387768	11397669	0.8396	3337137
Year 4	3229556	4617324	14627225	0.7921	2558111
TOTAL			14627225		12686174

The Net Present Value at 6% discount rate is 2676273

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Fund Coastal 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 Fund Coastal 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 Coastal Ventures Limited Partnership: Balancing a Sustainable Investment Strategy with a Social Mission

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 Fund Coastal 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 Fund Coastal 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	(10009901)	-10009901	-	-
Year 1	3453327	-6556574	3453327	0.8696	3002893
Year 2	3969758	-2586816	7423085	0.7561	3001707
Year 3	3974584	1387768	11397669	0.6575	2613353
Year 4	3229556	4617324	14627225	0.5718	1846509
TOTAL					10464463

The Net NPV after 4 years is 454562

(10464463 - 10009901 )

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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	(10009901)	-10009901	-	-
Year 1	3453327	-6556574	3453327	0.8333	2877773
Year 2	3969758	-2586816	7423085	0.6944	2756776
Year 3	3974584	1387768	11397669	0.5787	2300106
Year 4	3229556	4617324	14627225	0.4823	1557463
TOTAL					9492119

The Net NPV after 4 years is -517782

At 20% discount rate the NPV is negative (9492119 - 10009901 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Fund Coastal 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 Fund Coastal has a NPV value higher than Zero then finance managers at Fund Coastal 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 Fund Coastal, then the stock price of the Fund Coastal 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 Fund Coastal 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 Coastal Ventures Limited Partnership: Balancing a Sustainable Investment Strategy with a Social Mission

References & Further Readings

Guy Stuart (2018), "Coastal Ventures Limited Partnership: Balancing a Sustainable Investment Strategy with a Social Mission Harvard Business Review Case Study. Published by HBR Publications.