NPV and Strategic Value Presented by Mark Heath
Overview • Who is MBH Management? • Managing by Project • NPV as a black box • Measuring strategic value • Negative NPVs • Payback and investment time horizons • Using IRR
MBH Management Pty Ltd • Founded in November 1999 • Frustrations of modern consulting practices • Strong growth potential in project management consulting industry
MBH Vision To be an Australian leader in business, environmental and socio-political change management following a Managing by Project approach.
MBH Mission To position the MBH brand as the leader in facilitating business growth and change
What is Managing by Project? • Vision – How a company should look in the long term • Strategy – Approach to achieve the vision • Project selection – Based on the strategic alignment and value created by a project • Project Management – The delivery mechanism for each project selected
MbP – How does it work? • Selection process • Prioritisation process • Directly involves the customer • Use of cross functional teams • Utilises a facilitated workshop approach
MbP – Why use this approach? • Fewer resources (time, money, people) • Fluid structure • Short life • Integrates multiple functions • Minimises non value-adding work • Delivers vision
Project Life Cycle PLAN ACCOMPLISH SOFT HARD PHASE 1 CONCEPT PHASE 2 DEVELOPMENT PHASE 3 IMPLEMENTATION PHASE 4 TERMINATION LEVEL OF EFFORT TIME
Removing the black box • Understand where +ve NPV comes from • Articulate benefit drivers (EVA) • Align project to business strategy
Only NPV is relevant • Not a black box • Measures strategic value • Incorporates risk • Creates instant priority process
Calculating NPV • Benefit drivers • Cost of the project • Ongoing costs • WACC • DCF = NPV
What is strategic value? • Project must be more than “Strategic” • Must add strategic value • Results in competitive advantage • Competitive advantage = +ve NPV • Competitive advantage = strategic value
How is strategic value achieved? • Build on existing strengths • Reduce weaknesses • Create new businesses • Create new options/opportunities • Reduce risk
Negative NPV project • Gut feel says yes • Appears to have competitive advantage • Time horizon is long • Possibilities of follow-on investments • Need to value options
Option pricing and NPV • Value option of follow-on investment • Estimate volatility of forecasts • Estimate time to investment decision • Plug into Black-Scholes formula • Add option value to NPV value • Positive number means project has value
The danger of payback • Short term investment horizons • The need for EPS growth now • Forced by investment analysts time horizons • Investment horizons need to change • Focus on 10 - 15 years rather than 1 - 3. • Remove going concern assumption!
Other assessment tools used • IRR • ROI • Payback • Gut feel • Political decision • CEO says so
Why not IRR • Negative IRR for positive NPV projects • Multiple rates of return possible • Excluding the wrong mutually exclusive project • IRR means NPV = 0 • Prefer NPV > 0!
Conclusion • Utilise MbP approach to business management • NPV & option pricing only for project selection • Understand where the value comes from