Hero MotoCorp 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 Hero MotoCorp case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Hero MotoCorp case study is a Harvard Business School (HBR) case study written by Tripti Ghosh Sharma, Naval Shevade. The Hero MotoCorp (referred as “Hero Motocorp” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, International business, Joint ventures, Leadership transitions, Manufacturing.

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 Hero MotoCorp Case Study

After a 26 year partnership in the Indian two-wheeler industry, Hero and Honda parted ways. Honda had now become one of Hero's main competitors. The case covers the reasons for the split, the challenges faced by Hero and the strategic initiatives it had to use to overcome these challenges. After the split, rebranding and re-positioning itself as a stand-alone brand was of primary importance to Hero MotoCorp. To ensure that Hero MotoCorp continued its association with the Indian consumers, it underwent a series of transition phases. With ever rising competition, Hero was putting all of its efforts into ensuring that it overcame each roadblock and maintained its number one position in the Indian two-wheeler market, but were the strategies producing results? Tripti Ghosh Sharma is affiliated with Institute of Management Technology-Ghaziabad. Naval Shevade is affiliated with Institute of Management Technology.

Case Authors : Tripti Ghosh Sharma, Naval Shevade

Topic : Strategy & Execution

Related Areas : International business, Joint ventures, Leadership transitions, Manufacturing

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Calculating Net Present Value (NPV) at 6% for Hero MotoCorp Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10028028)	-10028028	-	-
Year 1	3450697	-6577331	3450697	0.9434	3255375
Year 2	3954277	-2623054	7404974	0.89	3519292
Year 3	3956033	1332979	11361007	0.8396	3321562
Year 4	3236126	4569105	14597133	0.7921	2563315
TOTAL			14597133		12659543

The Net Present Value at 6% discount rate is 2631515

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. Net Present Value
2. Internal Rate of Return
3. Payback Period
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. Hero Motocorp 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 Hero Motocorp 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 Hero MotoCorp

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 Hero Motocorp 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 Hero Motocorp 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	(10028028)	-10028028	-	-
Year 1	3450697	-6577331	3450697	0.8696	3000606
Year 2	3954277	-2623054	7404974	0.7561	2990002
Year 3	3956033	1332979	11361007	0.6575	2601156
Year 4	3236126	4569105	14597133	0.5718	1850266
TOTAL					10442029

The Net NPV after 4 years is 414001

(10442029 - 10028028 )

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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	(10028028)	-10028028	-	-
Year 1	3450697	-6577331	3450697	0.8333	2875581
Year 2	3954277	-2623054	7404974	0.6944	2746026
Year 3	3956033	1332979	11361007	0.5787	2289371
Year 4	3236126	4569105	14597133	0.4823	1560632
TOTAL					9471609

The Net NPV after 4 years is -556419

At 20% discount rate the NPV is negative (9471609 - 10028028 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Hero Motocorp 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 Hero Motocorp has a NPV value higher than Zero then finance managers at Hero Motocorp 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 Hero Motocorp, then the stock price of the Hero Motocorp 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 Hero Motocorp 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 –

Understanding of risks involved in 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 can impact the cash flow of 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.

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 Hero MotoCorp

References & Further Readings

Tripti Ghosh Sharma, Naval Shevade (2018), "Hero MotoCorp Harvard Business Review Case Study. Published by HBR Publications.