Reliance Industries: An Indian Family Business Comes of Age in Global Energy and Petrochemicals 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 Reliance Industries: An Indian Family Business Comes of Age in Global Energy and Petrochemicals case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Reliance Industries: An Indian Family Business Comes of Age in Global Energy and Petrochemicals case study is a Harvard Business School (HBR) case study written by Kannan Ramaswamy. The Reliance Industries: An Indian Family Business Comes of Age in Global Energy and Petrochemicals (referred as “Petrochemicals Family” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, .

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 Reliance Industries: An Indian Family Business Comes of Age in Global Energy and Petrochemicals Case Study

Reliance Industries had evolved into a major player in the Asia Pacific region, and had begun to make its presence felt in the global petrochemicals and refining business segments. It had also made forays into exploration and production for oil and gas in multiple regions worldwide. This case study addresses the evolution of the company from a family-owned small-scale textile manufacturer to a global powerhouse within a few decades. It provides insights into how the company was able to trade on its competitive advantages at home in building a global strategy. Within the entrepreneurship and family business realm, the case allows for a rich thematic discussion around understanding the role of entrepreneurial leaders, the pros and cons of family control in large corporations, and impact on minority shareholders. From a global strategy perspective, the case provides a rich description of the nuances of building competitive advantage in emerging market contexts, the benefits of late movers in the race to globalize, and the unique modes of competition adopted by companies from newly industrializing countries. Since it is set in India, the case offers a comprehensive look at ground realities in that country, covering topics ranging from capital market conditions, governmental control and regulation as barriers to growth, and the role of external relationships management as a key competitive weapon in driving sustainable advantage

Case Authors : Kannan Ramaswamy

Topic : Strategy & Execution

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Reliance Industries: An Indian Family Business Comes of Age in Global Energy and Petrochemicals Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10025626)	-10025626	-	-
Year 1	3454501	-6571125	3454501	0.9434	3258963
Year 2	3969814	-2601311	7424315	0.89	3533120
Year 3	3971801	1370490	11396116	0.8396	3334801
Year 4	3242068	4612558	14638184	0.7921	2568022
TOTAL			14638184		12694906

The Net Present Value at 6% discount rate is 2669280

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. Payback Period
3. Internal Rate of Return
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 Petrochemicals Family 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. Petrochemicals Family 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 Reliance Industries: An Indian Family Business Comes of Age in Global Energy and Petrochemicals

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 Petrochemicals Family 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 Petrochemicals Family 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	(10025626)	-10025626	-	-
Year 1	3454501	-6571125	3454501	0.8696	3003914
Year 2	3969814	-2601311	7424315	0.7561	3001750
Year 3	3971801	1370490	11396116	0.6575	2611524
Year 4	3242068	4612558	14638184	0.5718	1853663
TOTAL					10470850

The Net NPV after 4 years is 445224

(10470850 - 10025626 )

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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	(10025626)	-10025626	-	-
Year 1	3454501	-6571125	3454501	0.8333	2878751
Year 2	3969814	-2601311	7424315	0.6944	2756815
Year 3	3971801	1370490	11396116	0.5787	2298496
Year 4	3242068	4612558	14638184	0.4823	1563497
TOTAL					9497559

The Net NPV after 4 years is -528067

At 20% discount rate the NPV is negative (9497559 - 10025626 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Petrochemicals Family 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 Petrochemicals Family has a NPV value higher than Zero then finance managers at Petrochemicals Family 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 Petrochemicals Family, then the stock price of the Petrochemicals Family 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 Petrochemicals Family 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 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.

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 Reliance Industries: An Indian Family Business Comes of Age in Global Energy and Petrochemicals

References & Further Readings

Kannan Ramaswamy (2018), "Reliance Industries: An Indian Family Business Comes of Age in Global Energy and Petrochemicals Harvard Business Review Case Study. Published by HBR Publications.