Odebrecht: Dreaming The Client's Dreams 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 Odebrecht: Dreaming The Client's Dreams case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Odebrecht: Dreaming The Client's Dreams case study is a Harvard Business School (HBR) case study written by Benoit Leleux, Anne Catrin Glemser. The Odebrecht: Dreaming The Client's Dreams (referred as “Odebrecht Marcelo” 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, Design, Emerging markets, Social responsibility, Sustainability.

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 Odebrecht: Dreaming The Client's Dreams Case Study

SALVADOR DA BAHIA - BRAZIL. When Marcelo Odebrecht took over executive control of Odebrecht in 2009, he knew that he would have to light his own beacon for the firm. The company, launched in 1944 and still family-controlled, exhibited a strong entrepreneurial empowerment culture rooted in the life and business philosophy of the founder Norberto, Marcelo's grandfather. This meant he could involve and rely on the support of major entrepreneur-partners of the firm in defining ambitious yet reachable targets for the firm.Vision 2020 aimed to achieve annual revenues in excess of $200 billion by offering innovative integrated solutions to major global challenges such as the availability of water, energy and infrastructure. To "dream the client's dreams," the plan required over 200,000 new employees worldwide, united by a common entrepreneurial bond. Such projections would have sounded extravagant for any other firm; for Odebrecht, these were simple linear extrapolations of the company's performance over the last 10 years, during which the firm grew its revenues at an annualized rate of over 21%... Odebrecht also aspired to become a model of sustainable development and socio-environmental responsibility. For this, it could already rely on its massive investments in "green" plastics and ethanol production facilities. It also rallied behind a colossal hydroelectric project, pioneering CSR practices and novel turbine and dam technology to reduce the impact of such facilities on sensitive Amazon ecosystems. These investments set the tune for the firm in the second decade of the century. For Marcelo, the issue was how to translate the vision into "a dream with a deadline." Could he depend on the old recipes for growth? Were historical clients the right ones going forward? Would the forces and culture that had created the opportunities in the past support the future? Was Odebrecht ready to handle another massive bout of growth? As Marcelo assumed sole executive leadership for the $23 billion family business at the age of 42, he was aware of his responsibility and challenges. He knew he was expected to build on his forefathers' successes, and they had set a very high bar for him, but he also knew he could rely on the entrepreneur-partners he inherited. Learning objectives: Managing growth, family business governance, succession, CSR, sustainable development, renewable energy, managing the value chain.

Case Authors : Benoit Leleux, Anne Catrin Glemser

Topic : Leadership & Managing People

Related Areas : Design, Emerging markets, Social responsibility, Sustainability

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Calculating Net Present Value (NPV) at 6% for Odebrecht: Dreaming The Client's Dreams Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10010859)	-10010859	-	-
Year 1	3453974	-6556885	3453974	0.9434	3258466
Year 2	3972890	-2583995	7426864	0.89	3535858
Year 3	3962838	1378843	11389702	0.8396	3327275
Year 4	3246542	4625385	14636244	0.7921	2571565
TOTAL			14636244		12693165

The Net Present Value at 6% discount rate is 2682306

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. Profitability Index
2. Internal Rate of Return
3. Net Present Value
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. Odebrecht Marcelo 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 Odebrecht Marcelo 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 Odebrecht: Dreaming The Client's Dreams

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 Odebrecht Marcelo 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 Odebrecht Marcelo 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	(10010859)	-10010859	-	-
Year 1	3453974	-6556885	3453974	0.8696	3003456
Year 2	3972890	-2583995	7426864	0.7561	3004076
Year 3	3962838	1378843	11389702	0.6575	2605630
Year 4	3246542	4625385	14636244	0.5718	1856221
TOTAL					10469383

The Net NPV after 4 years is 458524

(10469383 - 10010859 )

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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	(10010859)	-10010859	-	-
Year 1	3453974	-6556885	3453974	0.8333	2878312
Year 2	3972890	-2583995	7426864	0.6944	2758951
Year 3	3962838	1378843	11389702	0.5787	2293309
Year 4	3246542	4625385	14636244	0.4823	1565655
TOTAL					9496227

The Net NPV after 4 years is -514632

At 20% discount rate the NPV is negative (9496227 - 10010859 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Odebrecht Marcelo 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 Odebrecht Marcelo has a NPV value higher than Zero then finance managers at Odebrecht Marcelo 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 Odebrecht Marcelo, then the stock price of the Odebrecht Marcelo 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 Odebrecht Marcelo 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 can impact the cash flow of the project.

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.

Understanding of risks involved in the project.

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.

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 Odebrecht: Dreaming The Client's Dreams

References & Further Readings

Benoit Leleux, Anne Catrin Glemser (2018), "Odebrecht: Dreaming The Client's Dreams Harvard Business Review Case Study. Published by HBR Publications.