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Patagonia Sur: For-Profit Land Conservation in Chile 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 Patagonia Sur: For-Profit Land Conservation in Chile case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Patagonia Sur: For-Profit Land Conservation in Chile case study is a Harvard Business School (HBR) case study written by Arthur I Segel, Nicolas Ibanez, Jay Verjee. The Patagonia Sur: For-Profit Land Conservation in Chile (referred as “Patagonia Sur” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Competitive strategy, Entrepreneurship, Managing uncertainty, Risk management.

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 Patagonia Sur: For-Profit Land Conservation in Chile Case Study


To maximize their effectiveness, color cases should be printed in color.Warren Adams founded Patagonia Sur in 2007 as one of the world's first for-profit land conservation businesses. His goal was to purchase over 100,000 acres of land in southern Chile and to run a variety of sustainable businesses to generate annual returns for investors. Patagonia Sur planned to derive various streams of revenue from the land-including eco-tourism, sustainable land development, carbon credits, water rights and eco-brokerage-thereby giving a financial return to investors on top of achieving a positive environmental impact. By 2011, Warren had raised over $20 million from high net worth individuals and Patagonia Sur had over 60,000 acres in Patagonia under management. However, institutional investors seriously questioned whether Patagonia Sur could ever do more than break even on an annual basis. Further, they worried that in fact the risk of the investment went up significantly as the company spent both its capital and management time on so many different revenue streams. In addition, some investors felt that for-profit conservation was morally wrong. Warren needed to convince both individual and institutional investors that his vision would succeed in both generating returns and preserving the natural beauty of Patagonia.


Case Authors : Arthur I Segel, Nicolas Ibanez, Jay Verjee

Topic : Finance & Accounting

Related Areas : Competitive strategy, Entrepreneurship, Managing uncertainty, Risk management




Calculating Net Present Value (NPV) at 6% for Patagonia Sur: For-Profit Land Conservation in Chile Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10022748) -10022748 - -
Year 1 3462383 -6560365 3462383 0.9434 3266399
Year 2 3955967 -2604398 7418350 0.89 3520797
Year 3 3937795 1333397 11356145 0.8396 3306249
Year 4 3223142 4556539 14579287 0.7921 2553030
TOTAL 14579287 12646475




The Net Present Value at 6% discount rate is 2623727

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. Patagonia Sur 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 Patagonia Sur 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 Patagonia Sur: For-Profit Land Conservation in Chile

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 Patagonia Sur 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 Patagonia Sur 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 (10022748) -10022748 - -
Year 1 3462383 -6560365 3462383 0.8696 3010768
Year 2 3955967 -2604398 7418350 0.7561 2991279
Year 3 3937795 1333397 11356145 0.6575 2589164
Year 4 3223142 4556539 14579287 0.5718 1842842
TOTAL 10434053


The Net NPV after 4 years is 411305

(10434053 - 10022748 )








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 (10022748) -10022748 - -
Year 1 3462383 -6560365 3462383 0.8333 2885319
Year 2 3955967 -2604398 7418350 0.6944 2747199
Year 3 3937795 1333397 11356145 0.5787 2278817
Year 4 3223142 4556539 14579287 0.4823 1554370
TOTAL 9465705


The Net NPV after 4 years is -557043

At 20% discount rate the NPV is negative (9465705 - 10022748 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Patagonia Sur 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 Patagonia Sur has a NPV value higher than Zero then finance managers at Patagonia Sur 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 Patagonia Sur, then the stock price of the Patagonia Sur 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 Patagonia Sur 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.

What can impact the cash flow of the project.

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.






Negotiation Strategy of Patagonia Sur: For-Profit Land Conservation in Chile

References & Further Readings

Arthur I Segel, Nicolas Ibanez, Jay Verjee (2018), "Patagonia Sur: For-Profit Land Conservation in Chile Harvard Business Review Case Study. Published by HBR Publications.


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