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Eyewitness Surveillance 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 Eyewitness Surveillance case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Eyewitness Surveillance case study is a Harvard Business School (HBR) case study written by David Dodson. The Eyewitness Surveillance (referred as “Eyewitness Mccloy” 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, .

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 Eyewitness Surveillance Case Study


The Eyewitness Surveillance case tells the story of Rush Arnold and RT McCloy, friends who met while studying at Wharton, who raise a search fund under the name Channelstone Partners. In the fall of 2010, after having spent two-thirds of their search fund capital and reviewed over 200 companies, they came across Eyewitness Surveillance, a company specializing in the use of video technology to protect the assets of car dealerships. Eyewitness' cofounder, Vince Redland, was interested in selling the company to pursue other interests and Arnold and McCloy found the industry, company, and deal all compelling. Over the course of the next two months, they engaged in a due diligence process which further validated their interest in the company, but also raised several red flags. Among the issues highlighted in due diligence included widespread employee disgruntlement, particularly with Vince (who was also the top sales person), a reluctance to share detailed financial information, and an 11th hour disagreement about a contract clause stipulating that the purchase price would go down if monthly revenues declined after the close. Despite having conducted a thorough and in-depth due diligence process, Arnold and McCloy were at the end of their search capital and facing a deal that was on the brink. They were now faced with the question of whether or not they wanted to charge ahead, despite the red flags, or walk away, knowing that this could potentially be the end of the road.


Case Authors : David Dodson

Topic : Leadership & Managing People

Related Areas :




Calculating Net Present Value (NPV) at 6% for Eyewitness Surveillance Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10017107) -10017107 - -
Year 1 3451702 -6565405 3451702 0.9434 3256323
Year 2 3970476 -2594929 7422178 0.89 3533710
Year 3 3964330 1369401 11386508 0.8396 3328528
Year 4 3242556 4611957 14629064 0.7921 2568408
TOTAL 14629064 12686968




The Net Present Value at 6% discount rate is 2669861

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. Net Present Value
2. Payback Period
3. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Eyewitness Mccloy 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 Eyewitness Mccloy have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.






Formula and Steps to Calculate Net Present Value (NPV) of Eyewitness Surveillance

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 Eyewitness Mccloy 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 Eyewitness Mccloy 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 (10017107) -10017107 - -
Year 1 3451702 -6565405 3451702 0.8696 3001480
Year 2 3970476 -2594929 7422178 0.7561 3002250
Year 3 3964330 1369401 11386508 0.6575 2606611
Year 4 3242556 4611957 14629064 0.5718 1853942
TOTAL 10464284


The Net NPV after 4 years is 447177

(10464284 - 10017107 )








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 (10017107) -10017107 - -
Year 1 3451702 -6565405 3451702 0.8333 2876418
Year 2 3970476 -2594929 7422178 0.6944 2757275
Year 3 3964330 1369401 11386508 0.5787 2294172
Year 4 3242556 4611957 14629064 0.4823 1563733
TOTAL 9491598


The Net NPV after 4 years is -525509

At 20% discount rate the NPV is negative (9491598 - 10017107 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Eyewitness Mccloy 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 Eyewitness Mccloy has a NPV value higher than Zero then finance managers at Eyewitness Mccloy 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 Eyewitness Mccloy, then the stock price of the Eyewitness Mccloy 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 Eyewitness Mccloy 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 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.

Understanding of risks involved in the project.

What can impact the cash flow of 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.






Negotiation Strategy of Eyewitness Surveillance

References & Further Readings

David Dodson (2018), "Eyewitness Surveillance Harvard Business Review Case Study. Published by HBR Publications.


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