Bridging the Digital Divide: Indosat's Drive for Broadband Penetration in Indonesia 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 Bridging the Digital Divide: Indosat's Drive for Broadband Penetration in Indonesia case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Bridging the Digital Divide: Indosat's Drive for Broadband Penetration in Indonesia case study is a Harvard Business School (HBR) case study written by Havovi Joshi, Indranil Bose. The Bridging the Digital Divide: Indosat's Drive for Broadband Penetration in Indonesia (referred as “Broadband Indosat” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Economics, Emerging markets, Internet.

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 Bridging the Digital Divide: Indosat's Drive for Broadband Penetration in Indonesia Case Study

This case discusses the concepts of broadband and its adoption in developing and developed countries around the world, specifically in Indonesia. The telecom sector in Indonesia had under-developed infrastructure, and been dominated by two monopolies, PT Telkom and PT Indosat ("Indosat"), for many decades until September 2000, when the government opened up the sector to competition. The market has subsequently become highly competitive. This case highlights the strategies proposed by Indosat to succeed in this market, with broadband penetration being identified as one of the primary revenue-generating and growth areas for 2008. As is the case with most developing countries where the fixed-line infrastructure is minimal, the plan is for broadband technology to evolve through wireless platforms. This case can be used to understand Indosat's proposed strategy to promote broadband, particularly wireless broadband, in Indonesia. It can also be used to discuss the general issues that emerge in providing telecom services in a developing country, particularly where a formerly government-owned monopoly player faces an increasingly competitive market. The case provides students an opportunity to discuss the best way to implement the company's proposed strategy, given its competitive advantages and the constraints imposed by the external political, regulatory and economic environments.

Case Authors : Havovi Joshi, Indranil Bose

Topic : Strategy & Execution

Related Areas : Economics, Emerging markets, Internet

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Calculating Net Present Value (NPV) at 6% for Bridging the Digital Divide: Indosat's Drive for Broadband Penetration in Indonesia Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10028483)	-10028483	-	-
Year 1	3456623	-6571860	3456623	0.9434	3260965
Year 2	3968674	-2603186	7425297	0.89	3532106
Year 3	3945009	1341823	11370306	0.8396	3312306
Year 4	3247308	4589131	14617614	0.7921	2572172
TOTAL			14617614		12677549

The Net Present Value at 6% discount rate is 2649066

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. Net Present Value
3. Payback Period
4. Internal Rate of Return

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. Broadband Indosat 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 Broadband Indosat 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 Bridging the Digital Divide: Indosat's Drive for Broadband Penetration in Indonesia

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 Broadband Indosat 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 Broadband Indosat 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	(10028483)	-10028483	-	-
Year 1	3456623	-6571860	3456623	0.8696	3005759
Year 2	3968674	-2603186	7425297	0.7561	3000888
Year 3	3945009	1341823	11370306	0.6575	2593907
Year 4	3247308	4589131	14617614	0.5718	1856659
TOTAL					10457213

The Net NPV after 4 years is 428730

(10457213 - 10028483 )

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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	(10028483)	-10028483	-	-
Year 1	3456623	-6571860	3456623	0.8333	2880519
Year 2	3968674	-2603186	7425297	0.6944	2756024
Year 3	3945009	1341823	11370306	0.5787	2282991
Year 4	3247308	4589131	14617614	0.4823	1566024
TOTAL					9485558

The Net NPV after 4 years is -542925

At 20% discount rate the NPV is negative (9485558 - 10028483 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Broadband Indosat 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 Broadband Indosat has a NPV value higher than Zero then finance managers at Broadband Indosat 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 Broadband Indosat, then the stock price of the Broadband Indosat 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 Broadband Indosat 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 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 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 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 Bridging the Digital Divide: Indosat's Drive for Broadband Penetration in Indonesia

References & Further Readings

Havovi Joshi, Indranil Bose (2018), "Bridging the Digital Divide: Indosat's Drive for Broadband Penetration in Indonesia Harvard Business Review Case Study. Published by HBR Publications.