Aravind Eye Care's Vision Centers - Reaching Out to the Rural Poor 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 Aravind Eye Care's Vision Centers - Reaching Out to the Rural Poor case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Aravind Eye Care's Vision Centers - Reaching Out to the Rural Poor case study is a Harvard Business School (HBR) case study written by Shainesh G, Suhruta Kulkarni. The Aravind Eye Care's Vision Centers - Reaching Out to the Rural Poor (referred as “Vcs Vc” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Supply chain.

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 Aravind Eye Care's Vision Centers - Reaching Out to the Rural Poor Case Study

Aravind Eye Care Systems (Aravind) had started setting up vision centers (VC) in 2006 and 51 VCs were operational by March 2015. The location for each VC was chosen to ensure easy access for about 50,000 people across 15 to 20 villages within a 5-7 km radial distance. Each VC had a target of reaching at least 10% of the population, that is, around 5,000 patients, which served as a benchmark for penetration. Consultations related to eye care were provided at the VC. They also dispensed medicines and spectacles. The VC would facilitate arrangements for patients requiring surgeries at the base hospital, including their transport, food and any other reimbursement. Each VC had three key personnel - coordinator, ophthalmic technician, and field worker. The VC was equipped with basic ophthalmic equipment and internet connectivity. The presence of a permanent establishment, in the form of a VC, motivated people in rural areas to seek earlier treatment for vision problems. This helped in eliminating vision care problems and enabled them to get back to earning their livelihoods. The permanent setup also positively influenced the healthcare seeking behavior of the people. Most VCs had performed well, however some VCs were not attracting enough patients, thus not enabling Aravind's classic, volume-driven model, to work and support self-sustainable operations. Thulsiraj, Director of Aravind, was analyzing the performance of all VCs. How should he analyze the performance of VCs from a marketing perspective? Should he change the marketing strategies for those VCs which had attracted a very low number of patients and if yes, how will it be be designed, considering the unique market in which VC operates? Were the VCs innovative in their approach to reach out to patients? Were the VCs self-sustainable? What parameters should he use to evaluate the performance of VCs? How should he increase the number of patients at VCs?

Case Authors : Shainesh G, Suhruta Kulkarni

Topic : Sales & Marketing

Related Areas : Supply chain

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Calculating Net Present Value (NPV) at 6% for Aravind Eye Care's Vision Centers - Reaching Out to the Rural Poor Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10011895)	-10011895	-	-
Year 1	3443514	-6568381	3443514	0.9434	3248598
Year 2	3960208	-2608173	7403722	0.89	3524571
Year 3	3959819	1351646	11363541	0.8396	3324740
Year 4	3246038	4597684	14609579	0.7921	2571166
TOTAL			14609579		12669076

The Net Present Value at 6% discount rate is 2657181

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 Vcs Vc 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. Vcs Vc 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 Aravind Eye Care's Vision Centers - Reaching Out to the Rural Poor

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 Vcs Vc 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 Vcs Vc 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	(10011895)	-10011895	-	-
Year 1	3443514	-6568381	3443514	0.8696	2994360
Year 2	3960208	-2608173	7403722	0.7561	2994486
Year 3	3959819	1351646	11363541	0.6575	2603645
Year 4	3246038	4597684	14609579	0.5718	1855933
TOTAL					10448424

The Net NPV after 4 years is 436529

(10448424 - 10011895 )

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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	(10011895)	-10011895	-	-
Year 1	3443514	-6568381	3443514	0.8333	2869595
Year 2	3960208	-2608173	7403722	0.6944	2750144
Year 3	3959819	1351646	11363541	0.5787	2291562
Year 4	3246038	4597684	14609579	0.4823	1565412
TOTAL					9476713

The Net NPV after 4 years is -535182

At 20% discount rate the NPV is negative (9476713 - 10011895 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Vcs Vc 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 Vcs Vc has a NPV value higher than Zero then finance managers at Vcs Vc 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 Vcs Vc, then the stock price of the Vcs Vc 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 Vcs Vc 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 –

Understanding of risks involved in 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.

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 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 Aravind Eye Care's Vision Centers - Reaching Out to the Rural Poor

References & Further Readings

Shainesh G, Suhruta Kulkarni (2018), "Aravind Eye Care's Vision Centers - Reaching Out to the Rural Poor Harvard Business Review Case Study. Published by HBR Publications.