Thought Leader Interview: Bill George 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 Thought Leader Interview: Bill George case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Thought Leader Interview: Bill George case study is a Harvard Business School (HBR) case study written by Bill George, Karen Christensen. The Thought Leader Interview: Bill George (referred as “True Leadership's” 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, 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 Thought Leader Interview: Bill George Case Study

The former Medtronic CEO and current Professor of Management Practice at Harvard describes the importance of following your True North and explains why he refers to the past 10 years as "leadership's lost decade". He describes five types of leaders that often lose sight of their True North and get derailed. He also talks about the importance of leading an "integrated life" and shows that authentic leadership entails a transition from 'I' to 'we'.

Case Authors : Bill George, Karen Christensen

Topic : Leadership & Managing People

Related Areas : Organizational culture

Calculating Net Present Value (NPV) at 6% for Thought Leader Interview: Bill George Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10008508) -10008508 - -
Year 1 3450441 -6558067 3450441 0.9434 3255133
Year 2 3955378 -2602689 7405819 0.89 3520272
Year 3 3940374 1337685 11346193 0.8396 3308414
Year 4 3224265 4561950 14570458 0.7921 2553920
TOTAL 14570458 12637739

The Net Present Value at 6% discount rate is 2629231

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. Profitability Index
2. Payback Period
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. Timing of the expected cash flows – stockholders of True Leadership's 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. True Leadership's 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 Thought Leader Interview: Bill George

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 True Leadership's 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 True Leadership's 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 (10008508) -10008508 - -
Year 1 3450441 -6558067 3450441 0.8696 3000383
Year 2 3955378 -2602689 7405819 0.7561 2990834
Year 3 3940374 1337685 11346193 0.6575 2590860
Year 4 3224265 4561950 14570458 0.5718 1843484
TOTAL 10425561

The Net NPV after 4 years is 417053

(10425561 - 10008508 )

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 (10008508) -10008508 - -
Year 1 3450441 -6558067 3450441 0.8333 2875368
Year 2 3955378 -2602689 7405819 0.6944 2746790
Year 3 3940374 1337685 11346193 0.5787 2280309
Year 4 3224265 4561950 14570458 0.4823 1554912
TOTAL 9457379

The Net NPV after 4 years is -551129

At 20% discount rate the NPV is negative (9457379 - 10008508 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of True Leadership's 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 True Leadership's has a NPV value higher than Zero then finance managers at True Leadership's 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 True Leadership's, then the stock price of the True Leadership's 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 True Leadership's 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 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.

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

Bill George, Karen Christensen (2018), "Thought Leader Interview: Bill George Harvard Business Review Case Study. Published by HBR Publications.