Flaxo Exports: Managing People in a Small- to Medium-Sized Enterprise 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 Flaxo Exports: Managing People in a Small- to Medium-Sized Enterprise case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Flaxo Exports: Managing People in a Small- to Medium-Sized Enterprise case study is a Harvard Business School (HBR) case study written by Debi S. Saini. The Flaxo Exports: Managing People in a Small- to Medium-Sized Enterprise (referred as “Flaxo Exports” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Labor.

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 Flaxo Exports: Managing People in a Small- to Medium-Sized Enterprise Case Study

A very successful Indian SME manufactured furnishing textiles and was operating exclusively in the exports sector. The company had no formal human resource (HR) systems and procedures nor did it have an HR manager. The sole proprietor took his only young son, an MBA, as a partner. He had his father's consent to his ambitious plans of business expansion, including manufacturing similar products to cater to the needs of the domestic market, and in this regard wanted to cash in on the Flaxo brand that the company had built over the years in the exports market by strengthening it in the domestic market as well. Narrates the typical business strategy and people-management practices that are followed by SMEs in the Indian context and helps understand managing people in SMEs, including the employee relations situation and the whole structural and procedural dynamics that surrounds these activities. These activities at Flaxo are marked by the practice of paternalism by a caring employer, whose leadership style helps it in getting a competitive edge through a higher degree of employee commitment. Highlights certain indigenous practices of employment and work organization that have become part of the culture of this industry, and focuses on the ways in which the owner gets greater advantage by building on these practices. Raises the dilemma of the new partner (son of the earlier owner) as to whether he should establish formal HR systems and procedures in his attempt to build the Flaxo brand and thus to professionalize people management, or should he continue with the time-tested existing indigenous practices, which are cost-effective and presently working well.

Case Authors : Debi S. Saini

Topic : Organizational Development

Related Areas : Labor

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Calculating Net Present Value (NPV) at 6% for Flaxo Exports: Managing People in a Small- to Medium-Sized Enterprise Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10007644)	-10007644	-	-
Year 1	3460369	-6547275	3460369	0.9434	3264499
Year 2	3972310	-2574965	7432679	0.89	3535342
Year 3	3965814	1390849	11398493	0.8396	3329774
Year 4	3249343	4640192	14647836	0.7921	2573784
TOTAL			14647836		12703399

The Net Present Value at 6% discount rate is 2695755

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 Flaxo Exports 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. Flaxo Exports 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 Flaxo Exports: Managing People in a Small- to Medium-Sized Enterprise

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 Flaxo Exports 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 Flaxo Exports 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	(10007644)	-10007644	-	-
Year 1	3460369	-6547275	3460369	0.8696	3009017
Year 2	3972310	-2574965	7432679	0.7561	3003637
Year 3	3965814	1390849	11398493	0.6575	2607587
Year 4	3249343	4640192	14647836	0.5718	1857822
TOTAL					10478063

The Net NPV after 4 years is 470419

(10478063 - 10007644 )

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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	(10007644)	-10007644	-	-
Year 1	3460369	-6547275	3460369	0.8333	2883641
Year 2	3972310	-2574965	7432679	0.6944	2758549
Year 3	3965814	1390849	11398493	0.5787	2295031
Year 4	3249343	4640192	14647836	0.4823	1567006
TOTAL					9504226

The Net NPV after 4 years is -503418

At 20% discount rate the NPV is negative (9504226 - 10007644 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Flaxo Exports 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 Flaxo Exports has a NPV value higher than Zero then finance managers at Flaxo Exports 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 Flaxo Exports, then the stock price of the Flaxo Exports 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 Flaxo Exports 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 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 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.

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 Flaxo Exports: Managing People in a Small- to Medium-Sized Enterprise

References & Further Readings

Debi S. Saini (2018), "Flaxo Exports: Managing People in a Small- to Medium-Sized Enterprise Harvard Business Review Case Study. Published by HBR Publications.