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 & project selection - WBS

MbP – Why use this approach? Fewer resources (time, money, people) Fluid structure Short life Integrates multiple functions Minimises non value-adding work Delivers vision

PLANACCOMPLISH SOFTHARD LEVEL OF EFFORT TIME PHASE 1 CONCEPT PHASE 2 DEVELOPMENT PHASE 3 IMPLEMENTATION PHASE 4 TERMINATION Project Life Cycle

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 years rather than Remove going concern assumption!

Other assessment tools used IRRROIPayback 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