Callmate Telips (B): Orix Investment Bank Pakistan Limited - Callmate Risk Uncovered 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 Callmate Telips (B): Orix Investment Bank Pakistan Limited - Callmate Risk Uncovered case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Callmate Telips (B): Orix Investment Bank Pakistan Limited - Callmate Risk Uncovered case study is a Harvard Business School (HBR) case study written by Muntazar B. Ahmed. The Callmate Telips (B): Orix Investment Bank Pakistan Limited - Callmate Risk Uncovered (referred as “Callmate Ferguson” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. 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 Callmate Telips (B): Orix Investment Bank Pakistan Limited - Callmate Risk Uncovered Case Study

Callmate Telips Telecom Limited (Callmate) was in the telecommunications business, an industry in which the regulatory controls were gradually being undone by the government of Pakistan as part of an economic deregulation program. Callmate was the pioneer in the payphones and prepaid calling card industries in Pakistan. The events in the case demonstrate that the company strategy, as well as aggressive share price management, could be dangerous if there were no checks on the directors. All the directors of Callmate were close family members and the audit committee consisted of three of the directors. The external audit firm that audited Callmate was A.F. Ferguson & Co. (Ferguson), an affiliate of Price Waterhouse Coopers International. As Callmate was listed on the Karachi Stock Exchange, it was required to publish its financials quarterly after these had been reviewed by Ferguson. The company had received permission during early 1995 to enter into the long distance international market. A disagreement arose between the auditors and the company on the accounting policy related to revenue recognition. This dispute, along with the company trying to manage its share price, led to a number of problems that became public knowledge as the company tried to malign the auditors. The case examines corporate governance by examining the role of the external auditor, the conduct of the board of directors and the regulator of publicly listed companies.

Case Authors : Muntazar B. Ahmed

Topic : Finance & Accounting

Related Areas :

Calculating Net Present Value (NPV) at 6% for Callmate Telips (B): Orix Investment Bank Pakistan Limited - Callmate Risk Uncovered Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10002615) -10002615 - -
Year 1 3465612 -6537003 3465612 0.9434 3269445
Year 2 3955526 -2581477 7421138 0.89 3520404
Year 3 3972854 1391377 11393992 0.8396 3335685
Year 4 3233809 4625186 14627801 0.7921 2561480
TOTAL 14627801 12687014

The Net Present Value at 6% discount rate is 2684399

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. 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 Callmate Ferguson 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. Callmate Ferguson 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 Callmate Telips (B): Orix Investment Bank Pakistan Limited - Callmate Risk Uncovered

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 Finance & Accounting 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 Callmate Ferguson 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 Callmate Ferguson 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 %
Cash Flows
Year 0 (10002615) -10002615 - -
Year 1 3465612 -6537003 3465612 0.8696 3013576
Year 2 3955526 -2581477 7421138 0.7561 2990946
Year 3 3972854 1391377 11393992 0.6575 2612216
Year 4 3233809 4625186 14627801 0.5718 1848941
TOTAL 10465678

The Net NPV after 4 years is 463063

(10465678 - 10002615 )

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 %
Cash Flows
Year 0 (10002615) -10002615 - -
Year 1 3465612 -6537003 3465612 0.8333 2888010
Year 2 3955526 -2581477 7421138 0.6944 2746893
Year 3 3972854 1391377 11393992 0.5787 2299105
Year 4 3233809 4625186 14627801 0.4823 1559514
TOTAL 9493523

The Net NPV after 4 years is -509092

At 20% discount rate the NPV is negative (9493523 - 10002615 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Callmate Ferguson 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 Callmate Ferguson has a NPV value higher than Zero then finance managers at Callmate Ferguson 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 Callmate Ferguson, then the stock price of the Callmate Ferguson 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 Callmate Ferguson 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.

References & Further Readings

Muntazar B. Ahmed (2018), "Callmate Telips (B): Orix Investment Bank Pakistan Limited - Callmate Risk Uncovered Harvard Business Review Case Study. Published by HBR Publications.