HBR's 10 Must Reads 2017: The Definitive Management Ideas of the Year from Harvard Business Review (with bonus article "What Is Disruptive Innovation?") 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 HBR's 10 Must Reads 2017: The Definitive Management Ideas of the Year from Harvard Business Review (with bonus article "What Is Disruptive Innovation?") case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. HBR's 10 Must Reads 2017: The Definitive Management Ideas of the Year from Harvard Business Review (with bonus article "What Is Disruptive Innovation?") case study is a Harvard Business School (HBR) case study written by Harvard Business Review, Clayton M. Christensen, Adam M. Grant, Vijay Govindarajan. The HBR's 10 Must Reads 2017: The Definitive Management Ideas of the Year from Harvard Business Review (with bonus article "What Is Disruptive Innovation?") (referred as “Adam Christensen” 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, Change management, Collaboration, Communication, Competition, Data, Disruptive innovation, Health, IT, Marketing, Negotiations, Organizational structure, Psychology, Talent 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 HBR's 10 Must Reads 2017: The Definitive Management Ideas of the Year from Harvard Business Review (with bonus article "What Is Disruptive Innovation?") Case Study

A year's worth of management wisdom, all in one place. We've reviewed the ideas, insights, and best practices from the past year of Harvard Business Review to keep you up-to-date on the most cutting-edge, influential thinking driving business today. With authors from Clayton M. Christensen to Adam Grant and company examples from Intel to Uber, this volume brings the most current and important management conversations to your fingertips. This book will inspire you to: Rethink the way you work in the face of advancing automation; Transform your business using a platform strategy; Apply design thinking to create innovative products; Identify where too much collaboration may be holding your people back; See the theory of disruptive innovation in a brand new light; Recognize the signs that your cross-cultural negotiation may be falling apart. This collection of articles includes "Collaborative Overload," by Rob Cross, Reb Rebele, and Adam Grant; "Algorithms Need Managers, Too," by Michael Luca, Jon Kleinberg, and Sendhil Mullainathan; "Pipelines, Platforms, and the New Rules of Strategy," by Marshall W. Van Alstyne, Geoffrey G. Parker, and Sangeet Paul Choudary; "What Is Disruptive Innovation?," by Clayton M. Christensen, Michael Raynor, and Rory McDonald; "How Indra Nooyi Turned Design Thinking into Strategy," an interview with Indra Nooyi by Adi Ignatius; "Engineering Reverse Innovations," by Amos Winter and Vijay Govindarajan; "The Employer-Led Health Care Revolution," by Patricia A. McDonald, Robert S. Mecklenburg, and Lindsay A. Martin; "Getting to Si, Ja, Oui, Hai, and Da," by Erin Meyer; "The Limits of Empathy," by Adam Waytz; "People Before Strategy: A New Role for the CHRO," by Ram Charan, Dominic Barton, and Dennis Carey; and "Beyond Automation," by Thomas H. Davenport and Julia Kirby.

Case Authors : Harvard Business Review, Clayton M. Christensen, Adam M. Grant, Vijay Govindarajan

Topic : Leadership & Managing People

Related Areas : Change management, Collaboration, Communication, Competition, Data, Disruptive innovation, Health, IT, Marketing, Negotiations, Organizational structure, Psychology, Talent management

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Calculating Net Present Value (NPV) at 6% for HBR's 10 Must Reads 2017: The Definitive Management Ideas of the Year from Harvard Business Review (with bonus article "What Is Disruptive Innovation?") Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10003085)	-10003085	-	-
Year 1	3464068	-6539017	3464068	0.9434	3267989
Year 2	3957099	-2581918	7421167	0.89	3521804
Year 3	3969240	1387322	11390407	0.8396	3332650
Year 4	3250140	4637462	14640547	0.7921	2574415
TOTAL			14640547		12696858

The Net Present Value at 6% discount rate is 2693773

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. Net Present Value
2. Internal Rate of Return
3. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Adam Christensen 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 Adam Christensen 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 HBR's 10 Must Reads 2017: The Definitive Management Ideas of the Year from Harvard Business Review (with bonus article "What Is Disruptive Innovation?")

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 Adam Christensen 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 Adam Christensen 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	(10003085)	-10003085	-	-
Year 1	3464068	-6539017	3464068	0.8696	3012233
Year 2	3957099	-2581918	7421167	0.7561	2992135
Year 3	3969240	1387322	11390407	0.6575	2609840
Year 4	3250140	4637462	14640547	0.5718	1858278
TOTAL					10472486

The Net NPV after 4 years is 469401

(10472486 - 10003085 )

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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	(10003085)	-10003085	-	-
Year 1	3464068	-6539017	3464068	0.8333	2886723
Year 2	3957099	-2581918	7421167	0.6944	2747985
Year 3	3969240	1387322	11390407	0.5787	2297014
Year 4	3250140	4637462	14640547	0.4823	1567390
TOTAL					9499113

The Net NPV after 4 years is -503972

At 20% discount rate the NPV is negative (9499113 - 10003085 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Adam Christensen 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 Adam Christensen has a NPV value higher than Zero then finance managers at Adam Christensen 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 Adam Christensen, then the stock price of the Adam Christensen 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 Adam Christensen 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 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.

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.

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 HBR's 10 Must Reads 2017: The Definitive Management Ideas of the Year from Harvard Business Review (with bonus article "What Is Disruptive Innovation?")

References & Further Readings

Harvard Business Review, Clayton M. Christensen, Adam M. Grant, Vijay Govindarajan (2018), "HBR's 10 Must Reads 2017: The Definitive Management Ideas of the Year from Harvard Business Review (with bonus article "What Is Disruptive Innovation?") Harvard Business Review Case Study. Published by HBR Publications.