Preferred Customer Service at US Airways 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 Preferred Customer Service at US Airways case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Preferred Customer Service at US Airways case study is a Harvard Business School (HBR) case study written by Umit Akinc. The Preferred Customer Service at US Airways (referred as “Preferred Wait” 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, Customer service, Developing employees, Operations management.

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 Preferred Customer Service at US Airways Case Study

Repatriation of the previously off-shored call center operations of the US Airlines was being completed in the summer of 2011. Reservation Director of the East Region considered this to be an opportunity to high quality and faster service to the "preferred customers" by establishing a preferred customer desk at the Winston-Salem Center. The headquarters has asked the director to provide an in-depth analysis of the proposal's costs and benefits before it can be approved. The wider question of the case is to cogitate whether this initiative has merit. Is it likely to provide enough advantages (both quantifiable such as shorter average wait times and non-quantifiable such as the perception by the customers of the service quality) to justify any additional personnel costs? The call centers operate 24/7 and experience varying call volumes. This causes the required number of agents to economically achieve some targeted average wait times to greatly fluctuate during each time increment (e.g., each hour). Therefore the case, more narrowly, focuses on the challenges of (1) the fundamental trade-off between wait times and agent utilization; and (2) scheduling of the start times of the standard 8-hour shifts to provide adequate coverage during each period. The Instructor's manual provides extensive analyses based on multiserver queuing models and linear programming of these technical issues. In addition, the case provides rich opportunities to discuss human resource strategies and their role in securing competitive advantage.

Case Authors : Umit Akinc

Topic : Leadership & Managing People

Related Areas : Customer service, Developing employees, Operations management

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Calculating Net Present Value (NPV) at 6% for Preferred Customer Service at US Airways Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10026746)	-10026746	-	-
Year 1	3464563	-6562183	3464563	0.9434	3268456
Year 2	3981869	-2580314	7446432	0.89	3543849
Year 3	3951977	1371663	11398409	0.8396	3318156
Year 4	3239140	4610803	14637549	0.7921	2565702
TOTAL			14637549		12696163

The Net Present Value at 6% discount rate is 2669417

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. Net Present Value
3. Payback Period
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 Preferred Wait 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. Preferred Wait 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 Preferred Customer Service at US Airways

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 Preferred Wait 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 Preferred Wait 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	(10026746)	-10026746	-	-
Year 1	3464563	-6562183	3464563	0.8696	3012663
Year 2	3981869	-2580314	7446432	0.7561	3010865
Year 3	3951977	1371663	11398409	0.6575	2598489
Year 4	3239140	4610803	14637549	0.5718	1851989
TOTAL					10474006

The Net NPV after 4 years is 447260

(10474006 - 10026746 )

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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	(10026746)	-10026746	-	-
Year 1	3464563	-6562183	3464563	0.8333	2887136
Year 2	3981869	-2580314	7446432	0.6944	2765187
Year 3	3951977	1371663	11398409	0.5787	2287024
Year 4	3239140	4610803	14637549	0.4823	1562085
TOTAL					9501432

The Net NPV after 4 years is -525314

At 20% discount rate the NPV is negative (9501432 - 10026746 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Preferred Wait 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 Preferred Wait has a NPV value higher than Zero then finance managers at Preferred Wait 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 Preferred Wait, then the stock price of the Preferred Wait 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 Preferred Wait 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.

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

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.

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 Preferred Customer Service at US Airways

References & Further Readings

Umit Akinc (2018), "Preferred Customer Service at US Airways Harvard Business Review Case Study. Published by HBR Publications.