Kennedy and the Bay of Pigs 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 Kennedy and the Bay of Pigs case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Kennedy and the Bay of Pigs case study is a Harvard Business School (HBR) case study written by Stephen Bates, Richard Neustadt, Joshua Rosenbloom, Ernest May. The Kennedy and the Bay of Pigs (referred as “Cia Kennedy” 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, Crisis management, Decision making, Knowledge management, Leadership, Marketing, Strategic planning.

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 Kennedy and the Bay of Pigs Case Study

In April 1961, President Kennedy denied US military assistance to a force of CIA-trained Cuban exiles attacking Cuba, thus sealing the fate of the Bay of Pigs invasion. When the losses had been tallied, 114 exiles were dead, Castro was left with 1,200 prisoners, and the Kennedy administration was publicly embarrassed. The case recounts the formulation and failed execution of this CIA plan to invade Cuba. The authors trace the origins of the plan under the Eisenhower administration and follow Kennedy through his first three months in office, during which time he first heard of, then revised, and ultimately approved a trimmed-down version of the plan. This case was initially designed to illustrate the importance of decision-makers' identifying and testing their own and their advisers' presumptions. Extending this theme, the case may be used in conjunction with The CIA to 1961 (C14-80-280.0) as an exercise in "organizational placement." Had Kennedy used this method to better understand the institution of the CIA, he might have questioned them more closely and avoided some of the tragedy of the Bay of Pigs. For further discussion of the placement method, see The CIA to 1961 abstract. This case may also be used to demonstrate the hazards of transition in the American presidency. HKS Case Number 279.0.

Case Authors : Stephen Bates, Richard Neustadt, Joshua Rosenbloom, Ernest May

Topic : Leadership & Managing People

Related Areas : Crisis management, Decision making, Knowledge management, Leadership, Marketing, Strategic planning

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Calculating Net Present Value (NPV) at 6% for Kennedy and the Bay of Pigs Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10027473)	-10027473	-	-
Year 1	3464202	-6563271	3464202	0.9434	3268115
Year 2	3968993	-2594278	7433195	0.89	3532390
Year 3	3941747	1347469	11374942	0.8396	3309567
Year 4	3223148	4570617	14598090	0.7921	2553035
TOTAL			14598090		12663107

The Net Present Value at 6% discount rate is 2635634

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. Payback Period
3. Net Present Value
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 Cia Kennedy 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. Cia Kennedy 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 Kennedy and the Bay of Pigs

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 Cia Kennedy 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 Cia Kennedy 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	(10027473)	-10027473	-	-
Year 1	3464202	-6563271	3464202	0.8696	3012350
Year 2	3968993	-2594278	7433195	0.7561	3001129
Year 3	3941747	1347469	11374942	0.6575	2591763
Year 4	3223148	4570617	14598090	0.5718	1842845
TOTAL					10448086

The Net NPV after 4 years is 420613

(10448086 - 10027473 )

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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	(10027473)	-10027473	-	-
Year 1	3464202	-6563271	3464202	0.8333	2886835
Year 2	3968993	-2594278	7433195	0.6944	2756245
Year 3	3941747	1347469	11374942	0.5787	2281104
Year 4	3223148	4570617	14598090	0.4823	1554373
TOTAL					9478557

The Net NPV after 4 years is -548916

At 20% discount rate the NPV is negative (9478557 - 10027473 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Cia Kennedy 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 Cia Kennedy has a NPV value higher than Zero then finance managers at Cia Kennedy 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 Cia Kennedy, then the stock price of the Cia Kennedy 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 Cia Kennedy 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 will be a multi year spillover effect of various taxation regulations.

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.

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 Kennedy and the Bay of Pigs

References & Further Readings

Stephen Bates, Richard Neustadt, Joshua Rosenbloom, Ernest May (2018), "Kennedy and the Bay of Pigs Harvard Business Review Case Study. Published by HBR Publications.