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Nine Dragons Paper-2009 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 Nine Dragons Paper-2009 case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Nine Dragons Paper-2009 case study is a Harvard Business School (HBR) case study written by Michael Moffett, Brenda Adelson. The Nine Dragons Paper-2009 (referred as “Dragons Paper” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Financial analysis, Financial management.

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






Case Description of Nine Dragons Paper-2009 Case Study


Nine Dragons Paper (NDP) is the largest paperboard manufacturer in China and one of the largest in the world. Led by Mrs. Cheung, CEO, chairman, and founder, it has successfully grown to the top of the industry through a "grow at all costs" strategy. But in the spring of 2009, the company's rising debt levels had combined with declining margins to send the company's share price tumbling. The market was increasingly worried that Mrs. Cheung's strategy was putting the company at risk.


Case Authors : Michael Moffett, Brenda Adelson

Topic : Strategy & Execution

Related Areas : Financial analysis, Financial management




Calculating Net Present Value (NPV) at 6% for Nine Dragons Paper-2009 Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10027888) -10027888 - -
Year 1 3455649 -6572239 3455649 0.9434 3260046
Year 2 3977599 -2594640 7433248 0.89 3540049
Year 3 3958485 1363845 11391733 0.8396 3323620
Year 4 3224224 4588069 14615957 0.7921 2553887
TOTAL 14615957 12677603




The Net Present Value at 6% discount rate is 2649715

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.




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. Profitability Index
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. Dragons Paper 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 Dragons Paper have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.






Formula and Steps to Calculate Net Present Value (NPV) of Nine Dragons Paper-2009

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 Dragons Paper 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 Dragons Paper 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 (10027888) -10027888 - -
Year 1 3455649 -6572239 3455649 0.8696 3004912
Year 2 3977599 -2594640 7433248 0.7561 3007636
Year 3 3958485 1363845 11391733 0.6575 2602768
Year 4 3224224 4588069 14615957 0.5718 1843461
TOTAL 10458777


The Net NPV after 4 years is 430889

(10458777 - 10027888 )








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 (10027888) -10027888 - -
Year 1 3455649 -6572239 3455649 0.8333 2879708
Year 2 3977599 -2594640 7433248 0.6944 2762222
Year 3 3958485 1363845 11391733 0.5787 2290790
Year 4 3224224 4588069 14615957 0.4823 1554892
TOTAL 9487611


The Net NPV after 4 years is -540277

At 20% discount rate the NPV is negative (9487611 - 10027888 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Dragons Paper 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 Dragons Paper has a NPV value higher than Zero then finance managers at Dragons Paper 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 Dragons Paper, then the stock price of the Dragons Paper 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 Dragons Paper 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.






Negotiation Strategy of Nine Dragons Paper-2009

References & Further Readings

Michael Moffett, Brenda Adelson (2018), "Nine Dragons Paper-2009 Harvard Business Review Case Study. Published by HBR Publications.


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