New Strategies in Emerging Markets 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 New Strategies in Emerging Markets case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. New Strategies in Emerging Markets case study is a Harvard Business School (HBR) case study written by David J. Arnold, John A. Quelch. The New Strategies in Emerging Markets (referred as “Ems Frameworks” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Emerging markets.

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 New Strategies in Emerging Markets Case Study

This is an MIT Sloan Management Review article. Once viewed as "less developed countries," emerging markets (EMs) now offer a significant growth opportunity for multinational corporations. Because EMs differ dramatically from mature markets, they raise new strategic questions that traditional marketing frameworks do not resolve. Traditional models argue against first-mover advantages in EMs. However, additional sources of advantage--favorable government relations, pent-up demand, marketing productivity, marketing resources, and consequent learning--can make early market entry a desirable option. The authors provide a framework, oriented toward demand rather than risk, that enables companies to assess long-term market potential, identify business prospects, and predict potential benefits. Using the framework, companies can categorize EMs on the basis of short- and long-term potential. Once a multinational corporation decides to enter a market, it needs new frameworks to guide product and partner policy decisions. The different patterns of market development in EMs imply that, contrary to conventional models, companies can expand the market rapidly, should offer a combination of global imported brands and locally made joint venture brands, and use EMs to test product innovations. The design and management of relationships with local distributor partners is the most critical challenge for executives. In the areas of industry experience, direct selling, local autonomy, and exclusivity, experienced multinationals are adapting the approaches employed in developed markets in ways that are appropriate for emerging ones.

Case Authors : David J. Arnold, John A. Quelch

Topic : Strategy & Execution

Related Areas : Emerging markets

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Calculating Net Present Value (NPV) at 6% for New Strategies in Emerging Markets Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10025547)	-10025547	-	-
Year 1	3448778	-6576769	3448778	0.9434	3253564
Year 2	3966382	-2610387	7415160	0.89	3530066
Year 3	3942359	1331972	11357519	0.8396	3310081
Year 4	3227229	4559201	14584748	0.7921	2556268
TOTAL			14584748		12649978

The Net Present Value at 6% discount rate is 2624431

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. Payback Period
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Ems Frameworks 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 Ems Frameworks 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 New Strategies in Emerging Markets

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 Ems Frameworks 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 Ems Frameworks 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	(10025547)	-10025547	-	-
Year 1	3448778	-6576769	3448778	0.8696	2998937
Year 2	3966382	-2610387	7415160	0.7561	2999155
Year 3	3942359	1331972	11357519	0.6575	2592165
Year 4	3227229	4559201	14584748	0.5718	1845179
TOTAL					10435436

The Net NPV after 4 years is 409889

(10435436 - 10025547 )

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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	(10025547)	-10025547	-	-
Year 1	3448778	-6576769	3448778	0.8333	2873982
Year 2	3966382	-2610387	7415160	0.6944	2754432
Year 3	3942359	1331972	11357519	0.5787	2281458
Year 4	3227229	4559201	14584748	0.4823	1556341
TOTAL					9466213

The Net NPV after 4 years is -559334

At 20% discount rate the NPV is negative (9466213 - 10025547 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ems Frameworks 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 Ems Frameworks has a NPV value higher than Zero then finance managers at Ems Frameworks 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 Ems Frameworks, then the stock price of the Ems Frameworks 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 Ems Frameworks 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.

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Negotiation Strategy of New Strategies in Emerging Markets

References & Further Readings

David J. Arnold, John A. Quelch (2018), "New Strategies in Emerging Markets Harvard Business Review Case Study. Published by HBR Publications.