Mannai Corporation (B): Back From the Brink? 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 Mannai Corporation (B): Back From the Brink? case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Mannai Corporation (B): Back From the Brink? case study is a Harvard Business School (HBR) case study written by Stewart Hamilton, Sarah Hutton. The Mannai Corporation (B): Back From the Brink? (referred as “Mannai Higley” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Reorganization.

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 Mannai Corporation (B): Back From the Brink? Case Study

Mannai Corporation, one of the oldest and largest private enterprises in Qatar was facing ruin by the end of 2000. A combination of events had led to the company reaching its substantial bank borrowing limits and with interest obligations approaching $1 million a month, Mannai was close to collapse. A consortium of the company's creditor banks stepped in to assess the situation and attempt to avert a crisis in the Qatar economy. One of their initial priorities was the appointment of a strong CEO and after some persuasion, Keith Higley, an experienced banker who had spent a significant part of his career in the Middle East, accepted the challenge. Higley's initial mandate when he took over as CEO of Mannai Corporation on 12 March 2001 was two-fold: to keep the company afloat to allow fair values to be obtained for the numerous intended asset disposals and to make an informed decision as to whether a workout was feasible or not. A PricewaterhouseCoopers (PwC) report to the consortium of banks had outlined the options available. Liquidation was the first option, which would prevent any further spiralling of losses but would limit the prices obtained for the assets to be sold. An alternative would be to sell the business as a going concern, but any potential buyer would require a substantial write-off of the Mannai debt. The third option, probably the riskiest, was a workout involving a restructuring of the business. Whatever the banks' decided regarding the longer-term future of Mannai, Higley needed to tackle some issues immediately.

Case Authors : Stewart Hamilton, Sarah Hutton

Topic : Organizational Development

Related Areas : Reorganization

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Calculating Net Present Value (NPV) at 6% for Mannai Corporation (B): Back From the Brink? Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10014224)	-10014224	-	-
Year 1	3450816	-6563408	3450816	0.9434	3255487
Year 2	3966285	-2597123	7417101	0.89	3529980
Year 3	3961775	1364652	11378876	0.8396	3326383
Year 4	3227245	4591897	14606121	0.7921	2556280
TOTAL			14606121		12668129

The Net Present Value at 6% discount rate is 2653905

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. Profitability Index
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 Mannai Higley 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. Mannai Higley 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 Mannai Corporation (B): Back From the Brink?

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 Mannai Higley 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 Mannai Higley 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	(10014224)	-10014224	-	-
Year 1	3450816	-6563408	3450816	0.8696	3000710
Year 2	3966285	-2597123	7417101	0.7561	2999081
Year 3	3961775	1364652	11378876	0.6575	2604931
Year 4	3227245	4591897	14606121	0.5718	1845188
TOTAL					10449910

The Net NPV after 4 years is 435686

(10449910 - 10014224 )

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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	(10014224)	-10014224	-	-
Year 1	3450816	-6563408	3450816	0.8333	2875680
Year 2	3966285	-2597123	7417101	0.6944	2754365
Year 3	3961775	1364652	11378876	0.5787	2292694
Year 4	3227245	4591897	14606121	0.4823	1556349
TOTAL					9479087

The Net NPV after 4 years is -535137

At 20% discount rate the NPV is negative (9479087 - 10014224 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Mannai Higley 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 Mannai Higley has a NPV value higher than Zero then finance managers at Mannai Higley 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 Mannai Higley, then the stock price of the Mannai Higley 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 Mannai Higley 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 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.

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

Understanding of risks involved in the project.

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 Mannai Corporation (B): Back From the Brink?

References & Further Readings

Stewart Hamilton, Sarah Hutton (2018), "Mannai Corporation (B): Back From the Brink? Harvard Business Review Case Study. Published by HBR Publications.