ENOVE: Business Strategy in a Transitioning Economy 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 ENOVE: Business Strategy in a Transitioning Economy case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. ENOVE: Business Strategy in a Transitioning Economy case study is a Harvard Business School (HBR) case study written by Maciek Nowak, Alexander Stoll. The ENOVE: Business Strategy in a Transitioning Economy (referred as “Tunisia Enove” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Decision making, Emerging markets, Government, Manufacturing, Strategy.

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 ENOVE: Business Strategy in a Transitioning Economy Case Study

In August 2014, La SociA?tA? Energies Nouvelles & Environnement (ENOVE), a subdivision of Groupe Bismuth, was developing an expansion strategy in the unstable political and economic environment of Tunisia, the company's home country. Tunisia was the birthplace of the Arab Spring, a series of political revolutions that started in 2010 and swept the Mediterranean region for five years. Tunisia was also quickly moving toward a democratically elected government, but the transition was not an easy one; the country experienced a setback of about 10 to 15 years, in regards to economic development. Years of functional corruption under the long-time president, Ben Ali, were followed by sustained economic growth in manufacturing, tourism, and education. This led the economy into a governmental vacuum. For the first time, workers began exercising their rights to demand better conditions. There was little governmental oversight on customs, labour, or taxation. The threat of terrorism, whether real or perceived, was always present. Under these conditions, ENOVE's president had to make a decision: Should ENOVE expand within Tunisia, or move their manufacturing operations to a more stable country, perhaps nearby Morocco? Maciek Nowak is affiliated with Quinlan School of Business-Isom.

Case Authors : Maciek Nowak, Alexander Stoll

Topic : Strategy & Execution

Related Areas : Decision making, Emerging markets, Government, Manufacturing, Strategy

Calculating Net Present Value (NPV) at 6% for ENOVE: Business Strategy in a Transitioning Economy Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10024711) -10024711 - -
Year 1 3462514 -6562197 3462514 0.9434 3266523
Year 2 3966983 -2595214 7429497 0.89 3530601
Year 3 3970056 1374842 11399553 0.8396 3333336
Year 4 3240824 4615666 14640377 0.7921 2567036
TOTAL 14640377 12697495

The Net Present Value at 6% discount rate is 2672784

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

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. Tunisia Enove 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 Tunisia Enove 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 ENOVE: Business Strategy in a Transitioning Economy

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 Enove 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 Enove 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 %
Cash Flows
Year 0 (10024711) -10024711 - -
Year 1 3462514 -6562197 3462514 0.8696 3010882
Year 2 3966983 -2595214 7429497 0.7561 2999609
Year 3 3970056 1374842 11399553 0.6575 2610376
Year 4 3240824 4615666 14640377 0.5718 1852952
TOTAL 10473819

The Net NPV after 4 years is 449108

(10473819 - 10024711 )

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 %
Cash Flows
Year 0 (10024711) -10024711 - -
Year 1 3462514 -6562197 3462514 0.8333 2885428
Year 2 3966983 -2595214 7429497 0.6944 2754849
Year 3 3970056 1374842 11399553 0.5787 2297486
Year 4 3240824 4615666 14640377 0.4823 1562897
TOTAL 9500661

The Net NPV after 4 years is -524050

At 20% discount rate the NPV is negative (9500661 - 10024711 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Tunisia Enove 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 Enove has a NPV value higher than Zero then finance managers at Tunisia Enove 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 Enove, then the stock price of the Tunisia Enove 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 Enove 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 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.

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

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.

References & Further Readings

Maciek Nowak, Alexander Stoll (2018), "ENOVE: Business Strategy in a Transitioning Economy Harvard Business Review Case Study. Published by HBR Publications.