ITC LTD.: Toward a Triple Bottom Line Performance 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 ITC LTD.: Toward a Triple Bottom Line Performance case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. ITC LTD.: Toward a Triple Bottom Line Performance case study is a Harvard Business School (HBR) case study written by Abhoy Ojha. The ITC LTD.: Toward a Triple Bottom Line Performance (referred as “Itc Cigarette” 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, Decision making.

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 ITC LTD.: Toward a Triple Bottom Line Performance Case Study

The case describes the opportunities and challenges in the cigarette industry in India. The description suggests that there are tremendous opportunities for growth in the cigarette industry. However, there are challenges due to the health hazards associated with cigarette smoking, distortion in the tax system as applied to the cigarette industry, and restrictions on smoking placed by new legislation. Further, there are challenges in the market due to smuggling, contraband products, and other issues. The case presents ITC Limited as a dominant player in the industry with a significant dependence on tobacco and tobacco products promising to pursue the triple bottom line approach by focusing on economic, environmental and social value. There is a need for the company to decide on some directions for the future to live up to the promise of a triple bottom line approach. The case, based on the real issues faced by ITC Limited, will allow students to understand the dilemmas the firm faced in trying to meet the social demands to ban or restrict smoking. Any decision to stop producing and selling cigarettes has negative implications for the business. How does ITC Limited arrive at the right balance?

Case Authors : Abhoy Ojha

Topic : Leadership & Managing People

Related Areas : Decision making

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Calculating Net Present Value (NPV) at 6% for ITC LTD.: Toward a Triple Bottom Line Performance Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10005858)	-10005858	-	-
Year 1	3464430	-6541428	3464430	0.9434	3268330
Year 2	3974377	-2567051	7438807	0.89	3537181
Year 3	3974315	1407264	11413122	0.8396	3336912
Year 4	3231867	4639131	14644989	0.7921	2559941
TOTAL			14644989		12702364

The Net Present Value at 6% discount rate is 2696506

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. Net Present Value
2. Payback Period
3. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Itc Cigarette 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 Itc Cigarette 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 ITC LTD.: Toward a Triple Bottom Line Performance

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 Itc Cigarette 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 Itc Cigarette 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	(10005858)	-10005858	-	-
Year 1	3464430	-6541428	3464430	0.8696	3012548
Year 2	3974377	-2567051	7438807	0.7561	3005200
Year 3	3974315	1407264	11413122	0.6575	2613177
Year 4	3231867	4639131	14644989	0.5718	1847830
TOTAL					10478755

The Net NPV after 4 years is 472897

(10478755 - 10005858 )

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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	(10005858)	-10005858	-	-
Year 1	3464430	-6541428	3464430	0.8333	2887025
Year 2	3974377	-2567051	7438807	0.6944	2759984
Year 3	3974315	1407264	11413122	0.5787	2299951
Year 4	3231867	4639131	14644989	0.4823	1558578
TOTAL					9505538

The Net NPV after 4 years is -500320

At 20% discount rate the NPV is negative (9505538 - 10005858 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Itc Cigarette 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 Itc Cigarette has a NPV value higher than Zero then finance managers at Itc Cigarette 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 Itc Cigarette, then the stock price of the Itc Cigarette 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 Itc Cigarette 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 will be a multi year spillover effect of various taxation regulations.

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 can impact the cash flow of the project.

Understanding of risks involved in 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.

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Negotiation Strategy of ITC LTD.: Toward a Triple Bottom Line Performance

References & Further Readings

Abhoy Ojha (2018), "ITC LTD.: Toward a Triple Bottom Line Performance Harvard Business Review Case Study. Published by HBR Publications.