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Learning When to Stop Momentum 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 Learning When to Stop Momentum case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Learning When to Stop Momentum case study is a Harvard Business School (HBR) case study written by Michelle A. Barton, Kathleen M. Sutcliffe. The Learning When to Stop Momentum (referred as “Dysfunctional Momentum” 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 Learning When to Stop Momentum Case Study


This is an MIT Sloan Management Review article. "Dysfunctional momentum" occurs when people continue to work toward an original goal without pausing to recalibrate or reexamine their processes, even in the face of cues that suggest they should change course. In the authors' study of firefighting teams as a metaphor for business organizations, where dysfunctional momentum arises daily, they found that it has at least five possible causes: (1) an overemphasis on action and decisiveness, which often precludes meaningful assessment along the way; (2) evaluating people, processes and outcomes against plans rather than reevaluating the plans themselves; (3) the cumulative effects of small changes that can ripple and grow throughout the organization; (4) the tendency to ignore or co-opt disconfirming evidence; and (5) deference to authority even when leaders are not especially in the know. To overcome dysfunctional momentum, the authors conclude, we have to create interruptions -points at which we can ask: What's the story now? Is it the same story as before? If not, how has it changed? And how, if at all, should we adjust our actions? The people in charge need to stop and reassess what is happening around them. Two interconnected factors tend to be instrumental, say the authors. First, individuals have to recognize their own inability to understand fully and predict the unfolding situation by themselves -they have to develop "situated humility."Second, they must actively create or seek out disruptive information -they have to accept interruptions so that people may reevaluate the story they are maintaining in their minds.


Case Authors : Michelle A. Barton, Kathleen M. Sutcliffe

Topic : Leadership & Managing People

Related Areas : Leadership, Organizational culture




Calculating Net Present Value (NPV) at 6% for Learning When to Stop Momentum Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10022490) -10022490 - -
Year 1 3462740 -6559750 3462740 0.9434 3266736
Year 2 3970985 -2588765 7433725 0.89 3534163
Year 3 3960480 1371715 11394205 0.8396 3325295
Year 4 3229794 4601509 14623999 0.7921 2558299
TOTAL 14623999 12684493




The Net Present Value at 6% discount rate is 2662003

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. Net Present Value
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 Dysfunctional Momentum 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. Dysfunctional Momentum 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 Learning When to Stop Momentum

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 Dysfunctional Momentum 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 Dysfunctional Momentum 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 (10022490) -10022490 - -
Year 1 3462740 -6559750 3462740 0.8696 3011078
Year 2 3970985 -2588765 7433725 0.7561 3002635
Year 3 3960480 1371715 11394205 0.6575 2604080
Year 4 3229794 4601509 14623999 0.5718 1846645
TOTAL 10464439


The Net NPV after 4 years is 441949

(10464439 - 10022490 )








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 (10022490) -10022490 - -
Year 1 3462740 -6559750 3462740 0.8333 2885617
Year 2 3970985 -2588765 7433725 0.6944 2757628
Year 3 3960480 1371715 11394205 0.5787 2291944
Year 4 3229794 4601509 14623999 0.4823 1557578
TOTAL 9492768


The Net NPV after 4 years is -529722

At 20% discount rate the NPV is negative (9492768 - 10022490 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Dysfunctional Momentum 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 Dysfunctional Momentum has a NPV value higher than Zero then finance managers at Dysfunctional Momentum 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 Dysfunctional Momentum, then the stock price of the Dysfunctional Momentum 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 Dysfunctional Momentum 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.

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.

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.

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 Learning When to Stop Momentum

References & Further Readings

Michelle A. Barton, Kathleen M. Sutcliffe (2018), "Learning When to Stop Momentum Harvard Business Review Case Study. Published by HBR Publications.


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