×




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




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 :




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 (10024333) -10024333 - -
Year 1 3472696 -6551637 3472696 0.9434 3276128
Year 2 3964307 -2587330 7437003 0.89 3528219
Year 3 3964643 1377313 11401646 0.8396 3328791
Year 4 3247167 4624480 14648813 0.7921 2572060
TOTAL 14648813 12705199


The Net Present Value at 6% discount rate is 2680866

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. Internal Rate of Return
3. Profitability Index
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. Transparency Information 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 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.




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 (10024333) -10024333 - -
Year 1 3472696 -6551637 3472696 0.8696 3019736
Year 2 3964307 -2587330 7437003 0.7561 2997586
Year 3 3964643 1377313 11401646 0.6575 2606817
Year 4 3247167 4624480 14648813 0.5718 1856578
TOTAL 10480717


The Net NPV after 4 years is 456384

(10480717 - 10024333 )






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 (10024333) -10024333 - -
Year 1 3472696 -6551637 3472696 0.8333 2893913
Year 2 3964307 -2587330 7437003 0.6944 2752991
Year 3 3964643 1377313 11401646 0.5787 2294354
Year 4 3247167 4624480 14648813 0.4823 1565956
TOTAL 9507214


The Net NPV after 4 years is -517119

At 20% discount rate the NPV is negative (9507214 - 10024333 ) 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 will be a multi year spillover effect of various taxation regulations.

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.

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.

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.




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.