Developing the Next Generation of Enterprise Leaders 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 Developing the Next Generation of Enterprise Leaders case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Developing the Next Generation of Enterprise Leaders case study is a Harvard Business School (HBR) case study written by Douglas A. Ready, M. Ellen Peebles. The Developing the Next Generation of Enterprise Leaders (referred as “Enterprise Leaders” 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 Developing the Next Generation of Enterprise Leaders Case Study

This is an MIT Sloan Management Review article. A survey of top business executives from major international organizations found that 79% said it was extremely important to have leaders who act on behalf of the entire organization, not just their units. The rest said it was very important. Nearly 65% said they expected at least half of their senior and midlevel managers to behave as enterprise leaders -that is, executives who are as successful at serving the needs of the enterprise as they are at growing the units they head. The expectation that managers will know what's happening elsewhere in the enterprise is rising, authors Douglas A. Ready and M. Ellen Peebles write, but few organizations have been set up to support the development of such enterprise leaders. So how are managers learning to become effective enterprise leaders, and how can organizations encourage their development? The authors surveyed and interviewed scores of executives from the Americas, Europe, and Asia, and focused on three companies: Pfizer, Li & Fung, and Unilever. They found that regardless of the business or the location, enterprise leaders developed their capabilities in similar ways -through a combination of deliberate personal development, high-level mentoring, and opportunities afforded by their work that enabled strong unit performers to become even more effective as enterprise leaders. According to the authors, the essence of enterprise leadership lies in combining two often incompatible roles -those of builder and broker. That means executives need to build their unit's vision and integrate it into the wider corporate vision, clarifying where the enterprise is going and how their teams can best contribute, both within and beyond unit boundaries. They must build unit capabilities and share resources and business know-how across units to contribute to enterprisewide organizational capability. Balancing the goals of the unit with the broader interests of the enterprise can be difficult, the authors concede. Having come up the ranks in silos, managers acquire strong building skills -not the brokering skills top leaders said they needed. From their interviews, the authors identified six components of what they present as a mindset for the successful enterprise leader: a heightened sense of place; a broad sense of context; a sharp sense of perspective; a powerful sense of community; a deep sense of purpose; and an abiding sense of resiliency.

Case Authors : Douglas A. Ready, M. Ellen Peebles

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Developing the Next Generation of Enterprise Leaders Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016475)	-10016475	-	-
Year 1	3467713	-6548762	3467713	0.9434	3271427
Year 2	3977167	-2571595	7444880	0.89	3539664
Year 3	3962389	1390794	11407269	0.8396	3326898
Year 4	3246725	4637519	14653994	0.7921	2571710
TOTAL			14653994		12709700

The Net Present Value at 6% discount rate is 2693225

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

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. Enterprise Leaders 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 Enterprise Leaders 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 Developing the Next Generation of Enterprise Leaders

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 Enterprise Leaders 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 Enterprise Leaders 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	(10016475)	-10016475	-	-
Year 1	3467713	-6548762	3467713	0.8696	3015403
Year 2	3977167	-2571595	7444880	0.7561	3007310
Year 3	3962389	1390794	11407269	0.6575	2605335
Year 4	3246725	4637519	14653994	0.5718	1856326
TOTAL					10484373

The Net NPV after 4 years is 467898

(10484373 - 10016475 )

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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	(10016475)	-10016475	-	-
Year 1	3467713	-6548762	3467713	0.8333	2889761
Year 2	3977167	-2571595	7444880	0.6944	2761922
Year 3	3962389	1390794	11407269	0.5787	2293049
Year 4	3246725	4637519	14653994	0.4823	1565743
TOTAL					9510475

The Net NPV after 4 years is -506000

At 20% discount rate the NPV is negative (9510475 - 10016475 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Enterprise Leaders 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 Enterprise Leaders has a NPV value higher than Zero then finance managers at Enterprise Leaders 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 Enterprise Leaders, then the stock price of the Enterprise Leaders 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 Enterprise Leaders 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 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.

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 Developing the Next Generation of Enterprise Leaders

References & Further Readings

Douglas A. Ready, M. Ellen Peebles (2018), "Developing the Next Generation of Enterprise Leaders Harvard Business Review Case Study. Published by HBR Publications.