The Environment, Development and Participation: the Dilemmas of Asociacion Civil Labor 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 Environment, Development and Participation: the Dilemmas of Asociacion Civil Labor case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Environment, Development and Participation: the Dilemmas of Asociacion Civil Labor case study is a Harvard Business School (HBR) case study written by Felipe Portocarrero, Cynthia Sanborn, Elsa Del Castillo, Martha Chavez. The The Environment, Development and Participation: the Dilemmas of Asociacion Civil Labor (referred as “Labor Llo” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Decision making, Government, Influence, International business, Organizational culture, Social responsibility, Sustainability.

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 The Environment, Development and Participation: the Dilemmas of Asociacion Civil Labor Case Study

Asociacion Civil Labor is a private non-profit organization founded in 1981 in llo, a city located in an important mining and fishing region in southern Peru. Its original mission was to defend labor rights and promote leadership among workers in the mining industry, but during its first decade of operation this evolved into the defense of sustainable community development and the rights of communities affected by extractive activities. The labor case is particularly relevant for the analysis of some of the typical challenges faced by organizations whose institutional performance e is oriented toward advocacy and the defense of basic citizen rights. Over the years, Labor consolidated itself as an institution and had an important impact on the defense of the environment, the creation of greater awareness of the impact of the extractive activities, and the generation of public policy toward this sector in Peru. This case is particularly interesting because of the close relationship that the NGO maintained with the municipal government, which generated favorable results for the population of llo but also produced dilemmas with regard to the identity, mission, and autonomy of Labor. These dilemmas reached a critical point in 1997, when the proposal to build a new coal-fueled energy plant in an area zoned for tourism and recreation generated contrary opinions among the municipal authorities and the NGO staff, and divided the local population. The decisions that Labor made on this issue would have long term repercussions for the organization, which would have to redefine its relationship with a significant part of the population of llo as well as with municipal authorities and the NGO donors.

Case Authors : Felipe Portocarrero, Cynthia Sanborn, Elsa Del Castillo, Martha Chavez

Topic : Strategy & Execution

Related Areas : Decision making, Government, Influence, International business, Organizational culture, Social responsibility, Sustainability

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Calculating Net Present Value (NPV) at 6% for The Environment, Development and Participation: the Dilemmas of Asociacion Civil Labor Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016123)	-10016123	-	-
Year 1	3456533	-6559590	3456533	0.9434	3260880
Year 2	3973584	-2586006	7430117	0.89	3536476
Year 3	3972797	1386791	11402914	0.8396	3335637
Year 4	3244561	4631352	14647475	0.7921	2569996
TOTAL			14647475		12702989

The Net Present Value at 6% discount rate is 2686866

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. Profitability Index
3. Payback Period
4. Net Present Value

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 Labor Llo 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. Labor Llo 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 The Environment, Development and Participation: the Dilemmas of Asociacion Civil Labor

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 Strategy & Execution 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 Labor Llo 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 Labor Llo 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	(10016123)	-10016123	-	-
Year 1	3456533	-6559590	3456533	0.8696	3005681
Year 2	3973584	-2586006	7430117	0.7561	3004600
Year 3	3972797	1386791	11402914	0.6575	2612179
Year 4	3244561	4631352	14647475	0.5718	1855088
TOTAL					10477548

The Net NPV after 4 years is 461425

(10477548 - 10016123 )

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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	(10016123)	-10016123	-	-
Year 1	3456533	-6559590	3456533	0.8333	2880444
Year 2	3973584	-2586006	7430117	0.6944	2759433
Year 3	3972797	1386791	11402914	0.5787	2299072
Year 4	3244561	4631352	14647475	0.4823	1564700
TOTAL					9503649

The Net NPV after 4 years is -512474

At 20% discount rate the NPV is negative (9503649 - 10016123 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Labor Llo 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 Labor Llo has a NPV value higher than Zero then finance managers at Labor Llo 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 Labor Llo, then the stock price of the Labor Llo 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 Labor Llo 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 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.

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.

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 The Environment, Development and Participation: the Dilemmas of Asociacion Civil Labor

References & Further Readings

Felipe Portocarrero, Cynthia Sanborn, Elsa Del Castillo, Martha Chavez (2018), "The Environment, Development and Participation: the Dilemmas of Asociacion Civil Labor Harvard Business Review Case Study. Published by HBR Publications.