Ujaala Borderline General Insurance Company Limited 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 Ujaala Borderline General Insurance Company Limited case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Ujaala Borderline General Insurance Company Limited case study is a Harvard Business School (HBR) case study written by W. Glenn Rowe, Lyn Purdy, Uhnat Kohli. The Ujaala Borderline General Insurance Company Limited (referred as “Ujaala Borderline” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Influence, Leadership.

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 Ujaala Borderline General Insurance Company Limited Case Study

"In the last two years Ujaala Borderline had lost two key accounts and lost in the bidding process for a third large account. Ujaala Borderline's CEO and Executive VP Corporate Sales (Indian and MNC business) had just left a meeting with the firm's largest client - Sweekar Iron and Steel. Sweekar's CEO had informed them that he was taking his firm's business from Ujaala Borderline and going with another provider. The CEO had pointed out several servicing issues that had occurred over the last two years and considered that these issues had been ignored. First, there were errors in policies and several problems with delivery. Second, because of Ujaala Borderline's many organizational changes, managers at Sweekar were required to interact with several Ujaala Borderline staff - this issue was compounded by the claim from each Ujaala Borderline staff member that they owned the Sweekar account. Third, there were several mistakes in quotes. Fourth, Sweekar had three different relationship managers in four years because of the high staff turnover at Ujaala Borderline. Finally, a recent claim had not been settled to Sweekar's satisfaction. As the CEO left the meeting, he wondered what had happened. He had recently been profiled in a national newspaper as the CEO of the leading general insurer in India but now felt that he was embroiled in changes that he knew he had created. As he was thinking about the meeting with Sweekar's CEO and recent events he almost collided with an auto rickshaw. If Dhirender had not shouted a warning there probably would have been a collision. The CEO now realized that Ujaala Borderline had many problems and he knew that he had to act quickly and decisively to turn things around or else his job was at risk."

Case Authors : W. Glenn Rowe, Lyn Purdy, Uhnat Kohli

Topic : Strategy & Execution

Related Areas : Influence, Leadership

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Calculating Net Present Value (NPV) at 6% for Ujaala Borderline General Insurance Company Limited Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10004686)	-10004686	-	-
Year 1	3444830	-6559856	3444830	0.9434	3249840
Year 2	3969296	-2590560	7414126	0.89	3532659
Year 3	3957394	1366834	11371520	0.8396	3322704
Year 4	3234625	4601459	14606145	0.7921	2562126
TOTAL			14606145		12667329

The Net Present Value at 6% discount rate is 2662643

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. Internal Rate of Return
4. Payback Period

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. Ujaala Borderline 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 Ujaala Borderline 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 Ujaala Borderline General Insurance Company Limited

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 Ujaala Borderline 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 Ujaala Borderline 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	(10004686)	-10004686	-	-
Year 1	3444830	-6559856	3444830	0.8696	2995504
Year 2	3969296	-2590560	7414126	0.7561	3001358
Year 3	3957394	1366834	11371520	0.6575	2602051
Year 4	3234625	4601459	14606145	0.5718	1849407
TOTAL					10448321

The Net NPV after 4 years is 443635

(10448321 - 10004686 )

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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	(10004686)	-10004686	-	-
Year 1	3444830	-6559856	3444830	0.8333	2870692
Year 2	3969296	-2590560	7414126	0.6944	2756456
Year 3	3957394	1366834	11371520	0.5787	2290159
Year 4	3234625	4601459	14606145	0.4823	1559908
TOTAL					9477214

The Net NPV after 4 years is -527472

At 20% discount rate the NPV is negative (9477214 - 10004686 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ujaala Borderline 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 Ujaala Borderline has a NPV value higher than Zero then finance managers at Ujaala Borderline 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 Ujaala Borderline, then the stock price of the Ujaala Borderline 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 Ujaala Borderline 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.

Understanding of risks involved in the project.

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 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 Ujaala Borderline General Insurance Company Limited

References & Further Readings

W. Glenn Rowe, Lyn Purdy, Uhnat Kohli (2018), "Ujaala Borderline General Insurance Company Limited Harvard Business Review Case Study. Published by HBR Publications.