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Open Leadership: A New Paradigm Emerges 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 Open Leadership: A New Paradigm Emerges case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Open Leadership: A New Paradigm Emerges case study is a Harvard Business School (HBR) case study written by Charlene Li, Karen Christensen. The Open Leadership: A New Paradigm Emerges (referred as “Openness Continuum” 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, Leadership, Strategy.

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






Case Description of Open Leadership: A New Paradigm Emerges Case Study


In this interview, best-selling author and social media expert Charlene Li talks about the new openness and the implications for leaders everywhere. According to Li, these include embracing four objectives of openness: learn, dialog, support and innovate. She describes each in detail and shows that just as there is a continuum of openness for organizations, there is also a continuum of openness for leaders. She describes four 'openness archetypes' and the particular challenges faced by each, as well as the need for every organization to clearly define its 'sandbox'. In the end, she shows that leaders never really had total control over their customers and employees; what they have to give up now is the need for control.


Case Authors : Charlene Li, Karen Christensen

Topic : Leadership & Managing People

Related Areas : Leadership, Strategy




Calculating Net Present Value (NPV) at 6% for Open Leadership: A New Paradigm Emerges Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10013850) -10013850 - -
Year 1 3444786 -6569064 3444786 0.9434 3249798
Year 2 3982674 -2586390 7427460 0.89 3544566
Year 3 3941560 1355170 11369020 0.8396 3309410
Year 4 3250240 4605410 14619260 0.7921 2574495
TOTAL 14619260 12678268




The Net Present Value at 6% discount rate is 2664418

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.




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. Payback Period
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. Timing of the expected cash flows – stockholders of Openness Continuum 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. Openness Continuum shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of Open Leadership: A New Paradigm Emerges

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 Openness Continuum 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 Openness Continuum 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 (10013850) -10013850 - -
Year 1 3444786 -6569064 3444786 0.8696 2995466
Year 2 3982674 -2586390 7427460 0.7561 3011474
Year 3 3941560 1355170 11369020 0.6575 2591640
Year 4 3250240 4605410 14619260 0.5718 1858335
TOTAL 10456915


The Net NPV after 4 years is 443065

(10456915 - 10013850 )








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 (10013850) -10013850 - -
Year 1 3444786 -6569064 3444786 0.8333 2870655
Year 2 3982674 -2586390 7427460 0.6944 2765746
Year 3 3941560 1355170 11369020 0.5787 2280995
Year 4 3250240 4605410 14619260 0.4823 1567438
TOTAL 9484834


The Net NPV after 4 years is -529016

At 20% discount rate the NPV is negative (9484834 - 10013850 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Openness Continuum 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 Openness Continuum has a NPV value higher than Zero then finance managers at Openness Continuum 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 Openness Continuum, then the stock price of the Openness Continuum 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 Openness Continuum 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 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.

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.






Negotiation Strategy of Open Leadership: A New Paradigm Emerges

References & Further Readings

Charlene Li, Karen Christensen (2018), "Open Leadership: A New Paradigm Emerges Harvard Business Review Case Study. Published by HBR Publications.


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