Beyond Bias: How to Shift Ingrained Thinking 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 Beyond Bias: How to Shift Ingrained Thinking case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Beyond Bias: How to Shift Ingrained Thinking case study is a Harvard Business School (HBR) case study written by Heidi Grant Halvorson, David Rock. The Beyond Bias: How to Shift Ingrained Thinking (referred as “Biases Bias” 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, Organizational culture.

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 Beyond Bias: How to Shift Ingrained Thinking Case Study

Whether we admit it or not, common, everyday biases influence how we see the world. The fact is, we cannot go shopping, enter a conversation, or make a decision without a bias of some sort kicking in. The authors show that the best way to overcome common biases in the workplace is collectively. They describe five classes of common biases that all leaders should be familiar with, and show how team-based practices can be redesigned to help identify biases as they emerge, and counteract them on the fly.

Case Authors : Heidi Grant Halvorson, David Rock

Topic : Leadership & Managing People

Related Areas : Leadership, Organizational culture

Calculating Net Present Value (NPV) at 6% for Beyond Bias: How to Shift Ingrained Thinking Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10015899) -10015899 - -
Year 1 3471368 -6544531 3471368 0.9434 3274875
Year 2 3975939 -2568592 7447307 0.89 3538572
Year 3 3959137 1390545 11406444 0.8396 3324168
Year 4 3249633 4640178 14656077 0.7921 2574014
TOTAL 14656077 12711629

The Net Present Value at 6% discount rate is 2695730

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. Net Present Value
2. Profitability Index
3. Internal Rate of Return
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 Biases Bias 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. Biases Bias 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 Beyond Bias: How to Shift Ingrained Thinking

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 Biases Bias 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 Biases Bias 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 %
Cash Flows
Year 0 (10015899) -10015899 - -
Year 1 3471368 -6544531 3471368 0.8696 3018581
Year 2 3975939 -2568592 7447307 0.7561 3006381
Year 3 3959137 1390545 11406444 0.6575 2603197
Year 4 3249633 4640178 14656077 0.5718 1857988
TOTAL 10486147

The Net NPV after 4 years is 470248

(10486147 - 10015899 )

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 %
Cash Flows
Year 0 (10015899) -10015899 - -
Year 1 3471368 -6544531 3471368 0.8333 2892807
Year 2 3975939 -2568592 7447307 0.6944 2761069
Year 3 3959137 1390545 11406444 0.5787 2291167
Year 4 3249633 4640178 14656077 0.4823 1567146
TOTAL 9512188

The Net NPV after 4 years is -503711

At 20% discount rate the NPV is negative (9512188 - 10015899 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Biases Bias 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 Biases Bias has a NPV value higher than Zero then finance managers at Biases Bias 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 Biases Bias, then the stock price of the Biases Bias 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 Biases Bias 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 –

Understanding of risks involved in 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.

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.

Negotiation Strategy of Beyond Bias: How to Shift Ingrained Thinking

References & Further Readings

Heidi Grant Halvorson, David Rock (2018), "Beyond Bias: How to Shift Ingrained Thinking Harvard Business Review Case Study. Published by HBR Publications.

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