When Two (or More) Heads are Better than One: The Promise and Pitfalls of Shared Leadership 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 When Two (or More) Heads are Better than One: The Promise and Pitfalls of Shared Leadership case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. When Two (or More) Heads are Better than One: The Promise and Pitfalls of Shared Leadership case study is a Harvard Business School (HBR) case study written by James O'Toole, Jay Galbraith, Edward E. Lawler III. The When Two (or More) Heads are Better than One: The Promise and Pitfalls of Shared Leadership (referred as “Leadership Divvying” 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, Managing people.

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 When Two (or More) Heads are Better than One: The Promise and Pitfalls of Shared Leadership Case Study

In both the business press and academic journals, corporate leadership typically is portrayed as a solo activity, the responsibility of one person at the top of an organizational hierarchy. However, evidence shows that shared leadership is not only common in the corporate world, it is often more effective than the storied "one-man shows." Ongoing research at the University of Southern California's Center for Effective Organizations pinpoints several factors needed to make joint leadership a success. Where two--or more--individuals share leadership, it turns out that making the arrangement work is more complicated than simply "divvying up the tasks." For example, sharing the limelight seems harder than sharing responsibility.

Case Authors : James O'Toole, Jay Galbraith, Edward E. Lawler III

Topic : Leadership & Managing People

Related Areas : Managing people

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Calculating Net Present Value (NPV) at 6% for When Two (or More) Heads are Better than One: The Promise and Pitfalls of Shared Leadership Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10029165)	-10029165	-	-
Year 1	3451053	-6578112	3451053	0.9434	3255710
Year 2	3976914	-2601198	7427967	0.89	3539439
Year 3	3967483	1366285	11395450	0.8396	3331175
Year 4	3234849	4601134	14630299	0.7921	2562303
TOTAL			14630299		12688628

The Net Present Value at 6% discount rate is 2659463

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. Profitability Index
2. Internal Rate of Return
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. Leadership Divvying 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 Leadership Divvying 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 When Two (or More) Heads are Better than One: The Promise and Pitfalls of Shared Leadership

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 Leadership Divvying 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 Leadership Divvying 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	(10029165)	-10029165	-	-
Year 1	3451053	-6578112	3451053	0.8696	3000916
Year 2	3976914	-2601198	7427967	0.7561	3007118
Year 3	3967483	1366285	11395450	0.6575	2608684
Year 4	3234849	4601134	14630299	0.5718	1849535
TOTAL					10466254

The Net NPV after 4 years is 437089

(10466254 - 10029165 )

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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	(10029165)	-10029165	-	-
Year 1	3451053	-6578112	3451053	0.8333	2875878
Year 2	3976914	-2601198	7427967	0.6944	2761746
Year 3	3967483	1366285	11395450	0.5787	2295997
Year 4	3234849	4601134	14630299	0.4823	1560016
TOTAL					9493636

The Net NPV after 4 years is -535529

At 20% discount rate the NPV is negative (9493636 - 10029165 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Leadership Divvying 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 Leadership Divvying has a NPV value higher than Zero then finance managers at Leadership Divvying 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 Leadership Divvying, then the stock price of the Leadership Divvying 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 Leadership Divvying 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 can impact the cash flow of the project.

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.

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 When Two (or More) Heads are Better than One: The Promise and Pitfalls of Shared Leadership

References & Further Readings

James O'Toole, Jay Galbraith, Edward E. Lawler III (2018), "When Two (or More) Heads are Better than One: The Promise and Pitfalls of Shared Leadership Harvard Business Review Case Study. Published by HBR Publications.