The IOI Group: Creating a Malaysian Palm Oil Multinational 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 IOI Group: Creating a Malaysian Palm Oil Multinational case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The IOI Group: Creating a Malaysian Palm Oil Multinational case study is a Harvard Business School (HBR) case study written by Marleen Dieleman, Megha Mittal. The The IOI Group: Creating a Malaysian Palm Oil Multinational (referred as “Ioi Palm” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Strategy.

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 IOI Group: Creating a Malaysian Palm Oil Multinational Case Study

The case discusses the story of the IOI Group, one of the largest palm oil players in Malaysia, which has seen rapid growth in the past two decades. Family-controlled since 1982, the IOI Group's main businesses initially were property and palm plantations. As a relative latecomer in the palm oil industry, it grew both organically and through acquisitions, and, in 2010, had sales of about US$4.3 billion and employed 30,000 people. Over the years, the IOI Group moved away from producing crude palm oil (CPO), a key commodity, and pursued a strategy of vertical integration by moving into downstream activities such as food ingredients manufacturing and oleochemicals. This transformed IOI from a Malaysian plantation company to a global ingredients manufacturer, making IOI a good example of a so-called "emerging market multinational." The case takes the point of view of the second generation family leader who is currently in charge of the downstream businesses, and discusses three challenges he faces in IOI's transformation process: 1) the issue of optimizing and integrating the global value chain; 2) the most suitable way to coordinate a multinational company with substantial global sales and operations; and 3) adaptation to changing needs of global customers. All this is supported by extensive information on the changing dynamics in the palm oil industry, where emerging market players are moving up the value chain, snapping up manufacturing assets from global fast-moving consumer goods companies, such as Unilever, while the latter increasingly focus on branded goods and seek to exit the lower margin and capital intensive manufacturing of ingredients. Students are asked to analyze the changing industry dynamics and provide recommendations given the goal to make IOI a leading palm oil player.

Case Authors : Marleen Dieleman, Megha Mittal

Topic : Strategy & Execution

Related Areas : Strategy

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Calculating Net Present Value (NPV) at 6% for The IOI Group: Creating a Malaysian Palm Oil Multinational Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10005933)	-10005933	-	-
Year 1	3468952	-6536981	3468952	0.9434	3272596
Year 2	3958367	-2578614	7427319	0.89	3522933
Year 3	3962789	1384175	11390108	0.8396	3327234
Year 4	3225771	4609946	14615879	0.7921	2555113
TOTAL			14615879		12677876

The Net Present Value at 6% discount rate is 2671943

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. Payback Period
2. Net Present Value
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. Ioi Palm 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 Ioi Palm 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 The IOI Group: Creating a Malaysian Palm Oil Multinational

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 Ioi Palm 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 Ioi Palm 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	(10005933)	-10005933	-	-
Year 1	3468952	-6536981	3468952	0.8696	3016480
Year 2	3958367	-2578614	7427319	0.7561	2993094
Year 3	3962789	1384175	11390108	0.6575	2605598
Year 4	3225771	4609946	14615879	0.5718	1844345
TOTAL					10459517

The Net NPV after 4 years is 453584

(10459517 - 10005933 )

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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	(10005933)	-10005933	-	-
Year 1	3468952	-6536981	3468952	0.8333	2890793
Year 2	3958367	-2578614	7427319	0.6944	2748866
Year 3	3962789	1384175	11390108	0.5787	2293281
Year 4	3225771	4609946	14615879	0.4823	1555638
TOTAL					9488578

The Net NPV after 4 years is -517355

At 20% discount rate the NPV is negative (9488578 - 10005933 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ioi Palm 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 Ioi Palm has a NPV value higher than Zero then finance managers at Ioi Palm 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 Ioi Palm, then the stock price of the Ioi Palm 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 Ioi Palm 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 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.

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.

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.

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Negotiation Strategy of The IOI Group: Creating a Malaysian Palm Oil Multinational

References & Further Readings

Marleen Dieleman, Megha Mittal (2018), "The IOI Group: Creating a Malaysian Palm Oil Multinational Harvard Business Review Case Study. Published by HBR Publications.