Ranbaxy Laboratories Limited: At the Crossroads 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 Ranbaxy Laboratories Limited: At the Crossroads case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Ranbaxy Laboratories Limited: At the Crossroads case study is a Harvard Business School (HBR) case study written by Amitava Chattopadhyay, Srivastava Swati. The Ranbaxy Laboratories Limited: At the Crossroads (referred as “Ranbaxy Cifran” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Emerging markets.

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 Ranbaxy Laboratories Limited: At the Crossroads Case Study

The case describes challenges facing Ranbaxy, the third largest pharmaceutical company in India, as it attempts to move from being a generics marketer, to a player in the branded drugs business. The case focuses on issues relating to the launch of Cifran OD, Ranbaxy's first drug based on a patented new drug delivery system.

Case Authors : Amitava Chattopadhyay, Srivastava Swati

Topic : Sales & Marketing

Related Areas : Emerging markets

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Calculating Net Present Value (NPV) at 6% for Ranbaxy Laboratories Limited: At the Crossroads Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016080)	-10016080	-	-
Year 1	3451040	-6565040	3451040	0.9434	3255698
Year 2	3980761	-2584279	7431801	0.89	3542863
Year 3	3947897	1363618	11379698	0.8396	3314730
Year 4	3243035	4606653	14622733	0.7921	2568787
TOTAL			14622733		12682079

The Net Present Value at 6% discount rate is 2665999

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. 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 Ranbaxy Cifran 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. Ranbaxy Cifran 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 Ranbaxy Laboratories Limited: At the Crossroads

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 Ranbaxy Cifran 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 Ranbaxy Cifran 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	(10016080)	-10016080	-	-
Year 1	3451040	-6565040	3451040	0.8696	3000904
Year 2	3980761	-2584279	7431801	0.7561	3010027
Year 3	3947897	1363618	11379698	0.6575	2595806
Year 4	3243035	4606653	14622733	0.5718	1854216
TOTAL					10460954

The Net NPV after 4 years is 444874

(10460954 - 10016080 )

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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	(10016080)	-10016080	-	-
Year 1	3451040	-6565040	3451040	0.8333	2875867
Year 2	3980761	-2584279	7431801	0.6944	2764417
Year 3	3947897	1363618	11379698	0.5787	2284663
Year 4	3243035	4606653	14622733	0.4823	1563964
TOTAL					9488910

The Net NPV after 4 years is -527170

At 20% discount rate the NPV is negative (9488910 - 10016080 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ranbaxy Cifran 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 Ranbaxy Cifran has a NPV value higher than Zero then finance managers at Ranbaxy Cifran 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 Ranbaxy Cifran, then the stock price of the Ranbaxy Cifran 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 Ranbaxy Cifran 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 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.

Understanding of risks involved in 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.

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Negotiation Strategy of Ranbaxy Laboratories Limited: At the Crossroads

References & Further Readings

Amitava Chattopadhyay, Srivastava Swati (2018), "Ranbaxy Laboratories Limited: At the Crossroads Harvard Business Review Case Study. Published by HBR Publications.