Australian Miners and the Resource Super Profit Tax 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 Australian Miners and the Resource Super Profit Tax case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Australian Miners and the Resource Super Profit Tax case study is a Harvard Business School (HBR) case study written by Andrew Delios, Donna Jimenez, Clarissa Turner. The Australian Miners and the Resource Super Profit Tax (referred as “Tax Rspt” 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 Australian Miners and the Resource Super Profit Tax Case Study

This case presents a means by which students can explore how government policy is influenced by the actions of stakeholders in an economy: firms, taxpayers, voters, unions, and other organizations. It highlights how policy-making can be a process endogenous to the interests and influence of the private sector, and not an exogenous one, even in domains that are the power reserve of public policy makers. In 2010, the ruling party in Australia has devised a new tax, the Resource Super Profit Tax (RSPT). This tax has been devised to enable national and state governments to benefit from the boom in the mining industry by expropriating a greater portion of the industry's earnings. The RSPT has been prepared without any input from major mining companies in Australia, and if implemented would represent a substantial increase in their tax payable. The case is presented from the perspective of the CEO of BHP Billiton, one of the largest mining companies in Australia. The situation considers what, if any, action can be taken to combat a tax that has already been devised by the government and is about to be implemented. Successful analysis of the case involves an evaluation of all stakeholders in the Australian economy that will be influenced by the imposition of the RSPT. After this is done, a strategy needs to be devised that will influence the government to withdraw a tax to which it has already demonstrated a firm commitment.

Case Authors : Andrew Delios, Donna Jimenez, Clarissa Turner

Topic : Strategy & Execution

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Australian Miners and the Resource Super Profit Tax Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012196)	-10012196	-	-
Year 1	3444045	-6568151	3444045	0.9434	3249099
Year 2	3971652	-2596499	7415697	0.89	3534756
Year 3	3974580	1378081	11390277	0.8396	3337134
Year 4	3222235	4600316	14612512	0.7921	2552312
TOTAL			14612512		12673301

The Net Present Value at 6% discount rate is 2661105

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. Profitability Index
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. Tax Rspt 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 Tax Rspt 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 Australian Miners and the Resource Super Profit Tax

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 Tax Rspt 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 Tax Rspt 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	(10012196)	-10012196	-	-
Year 1	3444045	-6568151	3444045	0.8696	2994822
Year 2	3971652	-2596499	7415697	0.7561	3003140
Year 3	3974580	1378081	11390277	0.6575	2613351
Year 4	3222235	4600316	14612512	0.5718	1842323
TOTAL					10453635

The Net NPV after 4 years is 441439

(10453635 - 10012196 )

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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	(10012196)	-10012196	-	-
Year 1	3444045	-6568151	3444045	0.8333	2870038
Year 2	3971652	-2596499	7415697	0.6944	2758092
Year 3	3974580	1378081	11390277	0.5787	2300104
Year 4	3222235	4600316	14612512	0.4823	1553933
TOTAL					9482166

The Net NPV after 4 years is -530030

At 20% discount rate the NPV is negative (9482166 - 10012196 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Tax Rspt 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 Tax Rspt has a NPV value higher than Zero then finance managers at Tax Rspt 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 Tax Rspt, then the stock price of the Tax Rspt 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 Tax Rspt 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 will be a multi year spillover effect of various taxation regulations.

What can impact the cash flow of 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.

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.

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 Australian Miners and the Resource Super Profit Tax

References & Further Readings

Andrew Delios, Donna Jimenez, Clarissa Turner (2018), "Australian Miners and the Resource Super Profit Tax Harvard Business Review Case Study. Published by HBR Publications.