When Governance Rhymes with Turbulence 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 When Governance Rhymes with Turbulence case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. When Governance Rhymes with Turbulence case study is a Harvard Business School (HBR) case study written by Tawfik Jelassi, Anouk Lavoie Orlick. The When Governance Rhymes with Turbulence (referred as “Tunisia Nobel” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, 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 When Governance Rhymes with Turbulence Case Study

Tunisia has been the only country to emerge from the Arab Spring with a successful transition to democracy. This case focuses on a critical period in this transition process, when the country appointed an interim government. The case zooms in on the leadership and governance challenges of this "caretaker" administration during its one-year mandate in 2014-2015. In order to convey the highly turbulent environment this government faced, the story centers on one of the cabinet ministers and his struggle to deal with students' protests, labor strikes and threats to national security. It also outlines the challenge of making ethical decisions and pursuing much-needed reforms in this context. The protagonist of the case - the Minister of Higher Education, Scientific Research and Information & Communication Technologies, Mr Tawfik Jelassi - is unusual in that he was a business school professor and dean with no political experience, who was plunged into a new environment and expected to "sink or swim." He had to learn to map out the constellation of stakeholders who were important to his decision-making and to understand the dynamics of political conflicts. He was a member of a diverse team: non-partisan "technocrats" coming from different sectors and countries. An esprit-de-corps and high-level coordination enabled the government team to achieve the objectives set by the country's National Dialogue Quartet at the outset of their mandate. In 2015, Tunisia was awarded the Nobel Peace Prize for having built a pluralistic democracy. The Norwegian Nobel Committee stated that: "The ultimate validation of the Quartet's historical effort came in the autumn of 2014, when the parliamentary and presidential elections were carried out. Both the technocratic government and the interim president resigned and were replaced by lawfully elected successors." This case offers a window into the governance challenges that this achievement entailed, given the highly turbulent environment of post-revolutionary Tunisia.

Case Authors : Tawfik Jelassi, Anouk Lavoie Orlick

Topic : Strategy & Execution

Related Areas : Leadership

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Calculating Net Present Value (NPV) at 6% for When Governance Rhymes with Turbulence Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10003150)	-10003150	-	-
Year 1	3455956	-6547194	3455956	0.9434	3260336
Year 2	3968393	-2578801	7424349	0.89	3531856
Year 3	3938440	1359639	11362789	0.8396	3306790
Year 4	3250942	4610581	14613731	0.7921	2575051
TOTAL			14613731		12674032

The Net Present Value at 6% discount rate is 2670882

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

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 Tunisia Nobel 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. Tunisia Nobel 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 When Governance Rhymes with Turbulence

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 Tunisia Nobel 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 Tunisia Nobel 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	(10003150)	-10003150	-	-
Year 1	3455956	-6547194	3455956	0.8696	3005179
Year 2	3968393	-2578801	7424349	0.7561	3000675
Year 3	3938440	1359639	11362789	0.6575	2589588
Year 4	3250942	4610581	14613731	0.5718	1858737
TOTAL					10454179

The Net NPV after 4 years is 451029

(10454179 - 10003150 )

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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	(10003150)	-10003150	-	-
Year 1	3455956	-6547194	3455956	0.8333	2879963
Year 2	3968393	-2578801	7424349	0.6944	2755828
Year 3	3938440	1359639	11362789	0.5787	2279190
Year 4	3250942	4610581	14613731	0.4823	1567777
TOTAL					9482758

The Net NPV after 4 years is -520392

At 20% discount rate the NPV is negative (9482758 - 10003150 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Tunisia Nobel 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 Tunisia Nobel has a NPV value higher than Zero then finance managers at Tunisia Nobel 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 Tunisia Nobel, then the stock price of the Tunisia Nobel 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 Tunisia Nobel 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.

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.

What will be a multi year spillover effect of various taxation regulations.

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.

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Negotiation Strategy of When Governance Rhymes with Turbulence

References & Further Readings

Tawfik Jelassi, Anouk Lavoie Orlick (2018), "When Governance Rhymes with Turbulence Harvard Business Review Case Study. Published by HBR Publications.