Ayala Corp. 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 Ayala Corp. case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Ayala Corp. case study is a Harvard Business School (HBR) case study written by Belen Villalonga, Raphael Amit, Chris Hartman. The Ayala Corp. (referred as “Ayala Zobel” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Financial analysis, Financial management, Risk management.

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 Ayala Corp. Case Study

Ayala Corporation is the oldest conglomerate in the Philippines and has been controlled by the Zobel de Ayala family for seven generations. Over the past 25 years, Ayala has evolved from a real estate family business into a highly diversified and professionally managed business group, with a significant number of non-family shareholders. Between the holding company and its four largest subsidiaries, the Ayala group accounts for a quarter of the market capitalization of the Philippines Stock Exchange. Provides data to assess the value created for Ayala's stockholders in the ten years leading up to 2006, when the transition to the seventh generation of the Zobel de Ayala family culminated.

Case Authors : Belen Villalonga, Raphael Amit, Chris Hartman

Topic : Organizational Development

Related Areas : Financial analysis, Financial management, Risk management

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Calculating Net Present Value (NPV) at 6% for Ayala Corp. Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10021649)	-10021649	-	-
Year 1	3455652	-6565997	3455652	0.9434	3260049
Year 2	3960197	-2605800	7415849	0.89	3524561
Year 3	3955786	1349986	11371635	0.8396	3321354
Year 4	3233428	4583414	14605063	0.7921	2561178
TOTAL			14605063		12667142

The Net Present Value at 6% discount rate is 2645493

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. Timing of the expected cash flows – stockholders of Ayala Zobel 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. Ayala Zobel 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 Ayala Corp.

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 Organizational Development 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 Ayala Zobel 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 Ayala Zobel 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	(10021649)	-10021649	-	-
Year 1	3455652	-6565997	3455652	0.8696	3004915
Year 2	3960197	-2605800	7415849	0.7561	2994478
Year 3	3955786	1349986	11371635	0.6575	2600994
Year 4	3233428	4583414	14605063	0.5718	1848723
TOTAL					10449109

The Net NPV after 4 years is 427460

(10449109 - 10021649 )

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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	(10021649)	-10021649	-	-
Year 1	3455652	-6565997	3455652	0.8333	2879710
Year 2	3960197	-2605800	7415849	0.6944	2750137
Year 3	3955786	1349986	11371635	0.5787	2289228
Year 4	3233428	4583414	14605063	0.4823	1559331
TOTAL					9478405

The Net NPV after 4 years is -543244

At 20% discount rate the NPV is negative (9478405 - 10021649 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ayala Zobel 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 Ayala Zobel has a NPV value higher than Zero then finance managers at Ayala Zobel 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 Ayala Zobel, then the stock price of the Ayala Zobel 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 Ayala Zobel 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 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 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.

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 Ayala Corp.

References & Further Readings

Belen Villalonga, Raphael Amit, Chris Hartman (2018), "Ayala Corp. Harvard Business Review Case Study. Published by HBR Publications.