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Asociacion Chilena de Seguridad (ACHS) 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 Asociacion Chilena de Seguridad (ACHS) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Asociacion Chilena de Seguridad (ACHS) case study is a Harvard Business School (HBR) case study written by Mladen Koljatic, Monica Silva. The Asociacion Chilena de Seguridad (ACHS) (referred as “Achs Chilena” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Joint ventures, Personnel policies, Succession planning.

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




Case Description of Asociacion Chilena de Seguridad (ACHS) Case Study


Outlines the history of the Asociacion Chilena de Seguridad (ACHS), a nonprofit organization dedicated to the prevention, treatment, and rehabilitation of work-related accidents and illnesses. ACHS is part of the Chilean system of "workers insurance organizations," known generically as "mutuales." By law, these organizations may not be administered directly or indirectly by any for-profit company. At the end of 2003, ACHS administered seven hospitals, 27 clinics, and 70 medical centers throughout Chile. However, due to efficiency in accident prevention and advancements in medical treatment, hospital infrastructure far exceeded demand. To deal with this problem, ACHS is reviewing a possible alliance with one of its competitors. Focuses on this dilemma, along with the pending succession of the organization's president, who has led for 45 years. Illustrates the delicate balance between pursuing financial goals and remaining loyal to the organization's mission.


Case Authors : Mladen Koljatic, Monica Silva

Topic : Organizational Development

Related Areas : Joint ventures, Personnel policies, Succession planning




Calculating Net Present Value (NPV) at 6% for Asociacion Chilena de Seguridad (ACHS) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10002711) -10002711 - -
Year 1 3451350 -6551361 3451350 0.9434 3255991
Year 2 3975285 -2576076 7426635 0.89 3537989
Year 3 3940424 1364348 11367059 0.8396 3308456
Year 4 3244037 4608385 14611096 0.7921 2569581
TOTAL 14611096 12672017


The Net Present Value at 6% discount rate is 2669306

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.




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. Net Present Value
3. Profitability Index
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 Achs Chilena 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. Achs Chilena shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.




Formula and Steps to Calculate Net Present Value (NPV) of Asociacion Chilena de Seguridad (ACHS)

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 Achs Chilena 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 Achs Chilena 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 (10002711) -10002711 - -
Year 1 3451350 -6551361 3451350 0.8696 3001174
Year 2 3975285 -2576076 7426635 0.7561 3005887
Year 3 3940424 1364348 11367059 0.6575 2590893
Year 4 3244037 4608385 14611096 0.5718 1854789
TOTAL 10452742


The Net NPV after 4 years is 450031

(10452742 - 10002711 )






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 (10002711) -10002711 - -
Year 1 3451350 -6551361 3451350 0.8333 2876125
Year 2 3975285 -2576076 7426635 0.6944 2760615
Year 3 3940424 1364348 11367059 0.5787 2280338
Year 4 3244037 4608385 14611096 0.4823 1564447
TOTAL 9481524


The Net NPV after 4 years is -521187

At 20% discount rate the NPV is negative (9481524 - 10002711 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Achs Chilena 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 Achs Chilena has a NPV value higher than Zero then finance managers at Achs Chilena 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 Achs Chilena, then the stock price of the Achs Chilena 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 Achs Chilena 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 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.

What can impact the cash flow of the project.

Understanding of risks involved in 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.

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.




References & Further Readings

Mladen Koljatic, Monica Silva (2018), "Asociacion Chilena de Seguridad (ACHS) Harvard Business Review Case Study. Published by HBR Publications.