Darwinians at the Gate: Sustainability, Innovation and Growth at DSM 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 Darwinians at the Gate: Sustainability, Innovation and Growth at DSM case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Darwinians at the Gate: Sustainability, Innovation and Growth at DSM case study is a Harvard Business School (HBR) case study written by Benoit Leleux, Jan Van Der Kaaij. The Darwinians at the Gate: Sustainability, Innovation and Growth at DSM (referred as “Dsm Sustainability” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Innovation, Sustainability, Venture capital.

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 Darwinians at the Gate: Sustainability, Innovation and Growth at DSM Case Study

For Feike Sijbesma, CEO of Royal DSM since 2007, rapid changes were normal as major trends were playing out. Global population swelled, the balance of wealth shifted, often increasing disparities and inequalities, while human beings remained hooked on using more resources than the planet could handle or replace. As early as 2010, DSM formulated a strategy to build on its strength in Life and Materials Sciences, capitalizing on what it saw as the most promising global megatrends, notably health & wellness, global shifts and energy & climate change. At DSM, sustainability went way beyond complying with laws and regulations: It was a key driver for innovation and a core value for the firm. In the aftermath of the financial crisis of 2007 and the ensuing recession, cost concerns came back to the forefront, pushing the sustainability agenda to the back. The sense of urgency on environmental and social issues was gone, so how could you convince people a totally different approach to doing business was needed? Could sustainability really be turned into an effective driver for innovation and ultimately improve a company's profitability? Were the three bottom lines - financial, social and environmental - really mutually self-reinforcing, instead of mutually exclusive? Proving the case to some still-reluctant financial investors could prove difficult. For DSM, the ultimate challenge to its broad-based sustainability agenda was quite clear: Could a case be made for sustainability as a key driver of value creation over the long term? Learning objectives: Sustainability as driver of innovation and growth, CSR in action, corporate venturing, sustainability strategies, growth management, portfolio management.

Case Authors : Benoit Leleux, Jan Van Der Kaaij

Topic : Strategy & Execution

Related Areas : Innovation, Sustainability, Venture capital

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Calculating Net Present Value (NPV) at 6% for Darwinians at the Gate: Sustainability, Innovation and Growth at DSM Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018344)	-10018344	-	-
Year 1	3470909	-6547435	3470909	0.9434	3274442
Year 2	3974278	-2573157	7445187	0.89	3537093
Year 3	3953386	1380229	11398573	0.8396	3319339
Year 4	3234224	4614453	14632797	0.7921	2561808
TOTAL			14632797		12692683

The Net Present Value at 6% discount rate is 2674339

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. Profitability Index
2. Internal Rate of Return
3. Net Present Value
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Dsm Sustainability 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 Dsm Sustainability have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Darwinians at the Gate: Sustainability, Innovation and Growth at DSM

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 Dsm Sustainability 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 Dsm Sustainability 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	(10018344)	-10018344	-	-
Year 1	3470909	-6547435	3470909	0.8696	3018182
Year 2	3974278	-2573157	7445187	0.7561	3005125
Year 3	3953386	1380229	11398573	0.6575	2599415
Year 4	3234224	4614453	14632797	0.5718	1849178
TOTAL					10471900

The Net NPV after 4 years is 453556

(10471900 - 10018344 )

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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	(10018344)	-10018344	-	-
Year 1	3470909	-6547435	3470909	0.8333	2892424
Year 2	3974278	-2573157	7445187	0.6944	2759915
Year 3	3953386	1380229	11398573	0.5787	2287839
Year 4	3234224	4614453	14632797	0.4823	1559715
TOTAL					9499893

The Net NPV after 4 years is -518451

At 20% discount rate the NPV is negative (9499893 - 10018344 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Dsm Sustainability 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 Dsm Sustainability has a NPV value higher than Zero then finance managers at Dsm Sustainability 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 Dsm Sustainability, then the stock price of the Dsm Sustainability 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 Dsm Sustainability 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 can impact the cash flow of 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 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.

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 Darwinians at the Gate: Sustainability, Innovation and Growth at DSM

References & Further Readings

Benoit Leleux, Jan Van Der Kaaij (2018), "Darwinians at the Gate: Sustainability, Innovation and Growth at DSM Harvard Business Review Case Study. Published by HBR Publications.