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Dunia Finance LLC (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 Dunia Finance LLC (B) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Dunia Finance LLC (B) case study is a Harvard Business School (HBR) case study written by Samuel E Bodily, Rajkumar Venkatesan. The Dunia Finance LLC (B) (referred as “Dunia Clv” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Sales.

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 Dunia Finance LLC (B) Case Study


This case follows Ali Hurbas's efforts to use data extracted from the Dunia data warehouse to establish potential customers' customer lifetime value (CLV). Hurbas plans to use a spreadsheet model to evaluate Dunia's various cross-selling activities and their effectiveness in creating the greatest CLV. First, students should explain how the spreadsheet reflects the way in which Dunia makes money from cross-selling. Then students should use the spreadsheet to conduct what-if analysis to see how combinations of activities might improve total CLV, and sensitivity analysis to understand how cost parameters and other parameters would affect profitability. A teaching note for this case series is available to instructors to aid in class preparation.


Case Authors : Samuel E Bodily, Rajkumar Venkatesan

Topic : Sales & Marketing

Related Areas : Sales




Calculating Net Present Value (NPV) at 6% for Dunia Finance LLC (B) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10027697) -10027697 - -
Year 1 3446673 -6581024 3446673 0.9434 3251578
Year 2 3963471 -2617553 7410144 0.89 3527475
Year 3 3959576 1342023 11369720 0.8396 3324536
Year 4 3232553 4574576 14602273 0.7921 2560485
TOTAL 14602273 12664074


The Net Present Value at 6% discount rate is 2636377

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. Payback Period
3. Internal Rate of Return
4. Profitability Index

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Dunia Clv shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Dunia Clv have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.




Formula and Steps to Calculate Net Present Value (NPV) of Dunia Finance LLC (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 Dunia Clv 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 Dunia Clv 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 (10027697) -10027697 - -
Year 1 3446673 -6581024 3446673 0.8696 2997107
Year 2 3963471 -2617553 7410144 0.7561 2996953
Year 3 3959576 1342023 11369720 0.6575 2603485
Year 4 3232553 4574576 14602273 0.5718 1848223
TOTAL 10445769


The Net NPV after 4 years is 418072

(10445769 - 10027697 )






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 (10027697) -10027697 - -
Year 1 3446673 -6581024 3446673 0.8333 2872228
Year 2 3963471 -2617553 7410144 0.6944 2752410
Year 3 3959576 1342023 11369720 0.5787 2291421
Year 4 3232553 4574576 14602273 0.4823 1558909
TOTAL 9474968


The Net NPV after 4 years is -552729

At 20% discount rate the NPV is negative (9474968 - 10027697 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Dunia Clv 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 Dunia Clv has a NPV value higher than Zero then finance managers at Dunia Clv 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 Dunia Clv, then the stock price of the Dunia Clv 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 Dunia Clv 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 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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

Samuel E Bodily, Rajkumar Venkatesan (2018), "Dunia Finance LLC (B) Harvard Business Review Case Study. Published by HBR Publications.