Kingfisher Airlines Nosedives: Can It Soar Again or Will It Remain Grounded? 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 Kingfisher Airlines Nosedives: Can It Soar Again or Will It Remain Grounded? case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Kingfisher Airlines Nosedives: Can It Soar Again or Will It Remain Grounded? case study is a Harvard Business School (HBR) case study written by Ritu Narang, Gaurav Mahajan, Mohd Hassan Khan. The Kingfisher Airlines Nosedives: Can It Soar Again or Will It Remain Grounded? (referred as “Kingfisher Airlines” 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

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Case Description of Kingfisher Airlines Nosedives: Can It Soar Again or Will It Remain Grounded? Case Study

This case is based on Kingfisher Airlines, the brainchild of Dr. Vijay Mallaya. It made a grand entrance into the Indian aviation industry as a single-class, all-economy air carrier in 2005. The company soon turned its focus to becoming a premium service operator offering high-class in-flight services and unrivalled luxuries. Subsequently, it took a number of steps to differentiate itself from other airlines, while also embarking upon an ambitious expansion plan. Its acquisition of an ailing airline, Air Deccan, combined with rising fuel costs and a rapidly changing business environment made its survival difficult. The company's bank accounts were frozen several times by the Income Tax Department and the Service Tax Department because of defaults on tax payments, leaving it cash dry. The battered airline had to temporarily suspend its operations from several cities and cope with a staggering debt load that had reached Rs. 7,000 crore by March 27, 2012. The staff was demoralized and some employees left the company due to the non-payment of salaries. There was also widespread anger among passengers owing to last-minute flight cancellations. The challenge facing its CEO, Sanjay Agarwal, was to make Kingfisher Airlines bounce back from its precarious position. The company had to tackle the issue of raising funds to meet its day-to-day expenses, maintain the current number of flights and perhaps also conduct a thorough review of its past policies and strategies and try to learn from the competitors that had managed to weather the storm and still remain profitable in the most unfavourable of business environments.

Case Authors : Ritu Narang, Gaurav Mahajan, Mohd Hassan Khan

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Kingfisher Airlines Nosedives: Can It Soar Again or Will It Remain Grounded? Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10006055)	-10006055	-	-
Year 1	3460266	-6545789	3460266	0.9434	3264402
Year 2	3970007	-2575782	7430273	0.89	3533292
Year 3	3963873	1388091	11394146	0.8396	3328144
Year 4	3236034	4624125	14630180	0.7921	2563242
TOTAL			14630180		12689080

The Net Present Value at 6% discount rate is 2683025

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. Internal Rate of Return
2. Payback Period
3. Net Present Value
4. Profitability Index

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 Kingfisher Airlines 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. Kingfisher Airlines 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 Kingfisher Airlines Nosedives: Can It Soar Again or Will It Remain Grounded?

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 Kingfisher Airlines 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 Kingfisher Airlines 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	(10006055)	-10006055	-	-
Year 1	3460266	-6545789	3460266	0.8696	3008927
Year 2	3970007	-2575782	7430273	0.7561	3001896
Year 3	3963873	1388091	11394146	0.6575	2606311
Year 4	3236034	4624125	14630180	0.5718	1850213
TOTAL					10467346

The Net NPV after 4 years is 461291

(10467346 - 10006055 )

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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	(10006055)	-10006055	-	-
Year 1	3460266	-6545789	3460266	0.8333	2883555
Year 2	3970007	-2575782	7430273	0.6944	2756949
Year 3	3963873	1388091	11394146	0.5787	2293908
Year 4	3236034	4624125	14630180	0.4823	1560587
TOTAL					9495000

The Net NPV after 4 years is -511055

At 20% discount rate the NPV is negative (9495000 - 10006055 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Kingfisher Airlines 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 Kingfisher Airlines has a NPV value higher than Zero then finance managers at Kingfisher Airlines 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 Kingfisher Airlines, then the stock price of the Kingfisher Airlines 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 Kingfisher Airlines 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 –

Understanding of risks involved in the project.

What can impact the cash flow of the project.

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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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 Kingfisher Airlines Nosedives: Can It Soar Again or Will It Remain Grounded?

References & Further Readings

Ritu Narang, Gaurav Mahajan, Mohd Hassan Khan (2018), "Kingfisher Airlines Nosedives: Can It Soar Again or Will It Remain Grounded? Harvard Business Review Case Study. Published by HBR Publications.