Tenaris: Creating a Global Leader from an Emerging Market 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 Tenaris: Creating a Global Leader from an Emerging Market case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Tenaris: Creating a Global Leader from an Emerging Market case study is a Harvard Business School (HBR) case study written by John Roberts, Charlie Catalano. The Tenaris: Creating a Global Leader from an Emerging Market (referred as “Tenaris Rocca” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Cross-cultural management, Globalization, Growth strategy, Organizational structure, Strategy execution.

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 Tenaris: Creating a Global Leader from an Emerging Market Case Study

In December 2003, Paolo Rocca, chairman and CEO of Tenaris S.A., could look back on a momentous first year for the company. Much had been accomplished since the formation of this leading global supplier of seamless steel pipe and related services in December 2002 via an exchange of the shares and American Depository Receipts of three separately listed pipe companies--Siderca in Argentina, Tamsa in Mexico, and Dalmine in Italy--for shares in the new company. The new company had eight manufacturing facilities variously located in South and North America, Europe, and Asia and distribution and sales centers present in over 20 countries. It enjoyed annual sales of $3.1 billion to the oil and gas, energy, and mechanical industries, a market-leading 19% share globally in seamless OCTG pipes (sold to the oil and gas industry), with particularly strong market shares in a number of national OCTG markets where it had local manufacturing. Despite these accomplishments, Tenaris faced challenges ahead as it sought to transform itself strategically and organizationally. Faced with a mature seamless steel pipe market, Rocca looked to further geographic expansion and a move into service provision to maintain growth and consolidate its market position. Both of these would require new skills and new ways of managing, especially on the human resources side. Building on the legal unification to transform Tenaris' 14,500 employees from eight heritage companies into one centrally aligned, unified operation was also proving to be a major managerial challenge as the company sought to realize the potential advantages of a sophisticated new organizational design. Further, the new organization needed to generate significant cost savings from the consolidation. What should Rocca expect from himself and his managers in the face of these changes? How would they need to manage differently in a unified global organization?

Case Authors : John Roberts, Charlie Catalano

Topic : Strategy & Execution

Related Areas : Cross-cultural management, Globalization, Growth strategy, Organizational structure, Strategy execution

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Calculating Net Present Value (NPV) at 6% for Tenaris: Creating a Global Leader from an Emerging Market Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10002581)	-10002581	-	-
Year 1	3447988	-6554593	3447988	0.9434	3252819
Year 2	3958474	-2596119	7406462	0.89	3523028
Year 3	3949809	1353690	11356271	0.8396	3316336
Year 4	3250793	4604483	14607064	0.7921	2574933
TOTAL			14607064		12667115

The Net Present Value at 6% discount rate is 2664534

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. Internal Rate of Return
3. Net Present Value
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. Timing of the expected cash flows – stockholders of Tenaris Rocca 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. Tenaris Rocca 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 Tenaris: Creating a Global Leader from an Emerging Market

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 Tenaris Rocca 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 Tenaris Rocca 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	(10002581)	-10002581	-	-
Year 1	3447988	-6554593	3447988	0.8696	2998250
Year 2	3958474	-2596119	7406462	0.7561	2993175
Year 3	3949809	1353690	11356271	0.6575	2597064
Year 4	3250793	4604483	14607064	0.5718	1858651
TOTAL					10447140

The Net NPV after 4 years is 444559

(10447140 - 10002581 )

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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	(10002581)	-10002581	-	-
Year 1	3447988	-6554593	3447988	0.8333	2873323
Year 2	3958474	-2596119	7406462	0.6944	2748940
Year 3	3949809	1353690	11356271	0.5787	2285769
Year 4	3250793	4604483	14607064	0.4823	1567705
TOTAL					9475738

The Net NPV after 4 years is -526843

At 20% discount rate the NPV is negative (9475738 - 10002581 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Tenaris Rocca 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 Tenaris Rocca has a NPV value higher than Zero then finance managers at Tenaris Rocca 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 Tenaris Rocca, then the stock price of the Tenaris Rocca 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 Tenaris Rocca 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 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Understanding of risks involved in 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.

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Negotiation Strategy of Tenaris: Creating a Global Leader from an Emerging Market

References & Further Readings

John Roberts, Charlie Catalano (2018), "Tenaris: Creating a Global Leader from an Emerging Market Harvard Business Review Case Study. Published by HBR Publications.