Leading in the Age of Super-Transparency 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 Leading in the Age of Super-Transparency case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Leading in the Age of Super-Transparency case study is a Harvard Business School (HBR) case study written by Robert Austin, David M. Upton. The Leading in the Age of Super-Transparency (referred as “Transparency Information” 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 Leading in the Age of Super-Transparency Case Study

This is an MIT Sloan Management Review article. When Martha Payne, a 9-year-old student in Argyll, Scotland, started a blog in April 2012 to photograph and rate her school lunches, she had no idea of the stir she would cause. The blog logged 2 million hits in its first six weeks. When the local area council asked her to stop, an online firestorm ensued and the council reversed its decision. It's a familiar story -every day, images or events with the potential to incite passions get captured digitally, posted to the Web, and "go viral."With social media, people share their experiences with friends or followers, who share with more people. Seemingly insignificant occurrences can strike a nerve with a nascent virtual community, and unsuspecting parties must respond to a dicey new problem. The capacity to generate causes and controversies almost instantly may be the most salient aspect of what authors Robert D. Austin and David M. Upton call the "super-transparent society." Historically, the authors explain, people in a particular community were the only ones who paid attention to the local goings-on. When information moved outside of that environment, it was due to deliberate action: some identifiable person or organization moving it. If you wanted to guard information, you built a barrier. Many things have changed, particularly the volume of information. The article suggests several steps that can help managers meet the new expectations for transparency, including the following: Examine your assumptions about how you can keep information contained. Review your strategy for dealing with vulnerability to unintended transparency. Review operations for issues that might be problematic if revealed. Assume that others will put out information about your organization for their own reasons and that you won't be able to prevent it. Recognize that new information flows change what people consider to be fair.

Case Authors : Robert Austin, David M. Upton

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Leading in the Age of Super-Transparency Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10007525)	-10007525	-	-
Year 1	3468696	-6538829	3468696	0.9434	3272355
Year 2	3966537	-2572292	7435233	0.89	3530204
Year 3	3968308	1396016	11403541	0.8396	3331868
Year 4	3244521	4640537	14648062	0.7921	2569965
TOTAL			14648062		12704391

The Net Present Value at 6% discount rate is 2696866

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. Payback Period
3. Net Present Value
4. Internal Rate of Return

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 Transparency Information 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. Transparency Information 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 Leading in the Age of Super-Transparency

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 Transparency Information 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 Transparency Information 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	(10007525)	-10007525	-	-
Year 1	3468696	-6538829	3468696	0.8696	3016257
Year 2	3966537	-2572292	7435233	0.7561	2999272
Year 3	3968308	1396016	11403541	0.6575	2609227
Year 4	3244521	4640537	14648062	0.5718	1855065
TOTAL					10479822

The Net NPV after 4 years is 472297

(10479822 - 10007525 )

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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	(10007525)	-10007525	-	-
Year 1	3468696	-6538829	3468696	0.8333	2890580
Year 2	3966537	-2572292	7435233	0.6944	2754540
Year 3	3968308	1396016	11403541	0.5787	2296475
Year 4	3244521	4640537	14648062	0.4823	1564680
TOTAL					9506274

The Net NPV after 4 years is -501251

At 20% discount rate the NPV is negative (9506274 - 10007525 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Transparency Information 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 Transparency Information has a NPV value higher than Zero then finance managers at Transparency Information 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 Transparency Information, then the stock price of the Transparency Information 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 Transparency Information 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 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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 Leading in the Age of Super-Transparency

References & Further Readings

Robert Austin, David M. Upton (2018), "Leading in the Age of Super-Transparency Harvard Business Review Case Study. Published by HBR Publications.