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The Tata Nano: The People's Car (B) 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 The Tata Nano: The People's Car (B) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Tata Nano: The People's Car (B) case study is a Harvard Business School (HBR) case study written by Paul W. Farris, Rajkumar Venkatesan. The The Tata Nano: The People's Car (B) (referred as “Tata's Nano” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, .

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 The Tata Nano: The People's Car (B) Case Study


In the follow-up to the A case of the same name, this case reveals post-launch results for Tata's $2,500 car. Students learn about Tata's promotion, price, place, segment, targeting, and positioning for marketing "the world's cheapest car." This case series is effective for MBA, undergraduate, and executive learners studying market segmentation, pricing, cannibalization risk, pricing, and break-even sales in the face of different price and cost scenarios. Did Tata choose the right marketing strategy? Did the Nano represent an evolution or a revolution in automobile marketing?


Case Authors : Paul W. Farris, Rajkumar Venkatesan

Topic : Sales & Marketing

Related Areas :




Calculating Net Present Value (NPV) at 6% for The Tata Nano: The People's Car (B) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10015494) -10015494 - -
Year 1 3468361 -6547133 3468361 0.9434 3272039
Year 2 3971131 -2576002 7439492 0.89 3534292
Year 3 3962943 1386941 11402435 0.8396 3327363
Year 4 3250233 4637174 14652668 0.7921 2574489
TOTAL 14652668 12708183


The Net Present Value at 6% discount rate is 2692689

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. Net Present Value
2. Internal Rate of Return
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 Tata's Nano 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. Tata's Nano 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 The Tata Nano: The People's Car (B)

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 Sales & Marketing 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 Tata's Nano 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 Tata's Nano 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 (10015494) -10015494 - -
Year 1 3468361 -6547133 3468361 0.8696 3015966
Year 2 3971131 -2576002 7439492 0.7561 3002746
Year 3 3962943 1386941 11402435 0.6575 2605699
Year 4 3250233 4637174 14652668 0.5718 1858331
TOTAL 10482742


The Net NPV after 4 years is 467248

(10482742 - 10015494 )






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 (10015494) -10015494 - -
Year 1 3468361 -6547133 3468361 0.8333 2890301
Year 2 3971131 -2576002 7439492 0.6944 2757730
Year 3 3962943 1386941 11402435 0.5787 2293370
Year 4 3250233 4637174 14652668 0.4823 1567435
TOTAL 9508835


The Net NPV after 4 years is -506659

At 20% discount rate the NPV is negative (9508835 - 10015494 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Tata's Nano 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 Tata's Nano has a NPV value higher than Zero then finance managers at Tata's Nano 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 Tata's Nano, then the stock price of the Tata's Nano 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 Tata's Nano 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.

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 can impact the cash flow of 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.




References & Further Readings

Paul W. Farris, Rajkumar Venkatesan (2018), "The Tata Nano: The People's Car (B) Harvard Business Review Case Study. Published by HBR Publications.