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Indian and Northern Affairs Canada - The New Horizon Farms Dilemma 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 Indian and Northern Affairs Canada - The New Horizon Farms Dilemma case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Indian and Northern Affairs Canada - The New Horizon Farms Dilemma case study is a Harvard Business School (HBR) case study written by David Sparling, Steven Koeckhoven. The Indian and Northern Affairs Canada - The New Horizon Farms Dilemma (referred as “Nations Inac” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Leadership, Organizational culture, 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 Indian and Northern Affairs Canada - The New Horizon Farms Dilemma Case Study


The director of Lands and Economic Development in the Ministry of Indian and Northern Affairs Canada (INAC) must make recommendations on how to handle challenges around a large farming company that leases land from First Nations communities in Western Canada. New Horizon Farms (NHF) has already leased over 180,000 acres from First Nations communities and plans to grow to one million acres. An immediate challenge is the leasing process whereby INAC must review and sign leases and receive lease payments, which are later turned over to the First Nations. The process slows the partnering process and the speed of cash flow to First Nations and many First Nations object to government control over their land on principle. However, without INAC involved, the leases are not legally enforceable, an essential factor for NHF and its public parent company. NHF provides leasing revenue but also training, employment, and shares in the company to the First Nations it partners with. On the surface it looks like a good opportunity, but it raises several questions for policy makers. Will NHF's control of one million acres of First Nations land be seen as a form of economic colonialism? How does this kind of initiative fit with INAC's and First Nations' mandates to improve economic and social conditions among First Nations communities? How will the provinces and neighbouring communities perceive and react to the situation? New Horizon Farms also needs to consider its long-term strategy. Will the operation meet its target of one million acres? What are the risks for the company? How should it approach the training issue now that funding has finished?


Case Authors : David Sparling, Steven Koeckhoven

Topic : Strategy & Execution

Related Areas : Leadership, Organizational culture, Strategy




Calculating Net Present Value (NPV) at 6% for Indian and Northern Affairs Canada - The New Horizon Farms Dilemma Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10002217) -10002217 - -
Year 1 3449130 -6553087 3449130 0.9434 3253896
Year 2 3955457 -2597630 7404587 0.89 3520343
Year 3 3962466 1364836 11367053 0.8396 3326963
Year 4 3240050 4604886 14607103 0.7921 2566423
TOTAL 14607103 12667625




The Net Present Value at 6% discount rate is 2665408

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. Profitability Index
2. Internal Rate of Return
3. Net Present Value
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. Nations Inac 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 Nations Inac 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 Indian and Northern Affairs Canada - The New Horizon Farms Dilemma

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 Nations Inac 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 Nations Inac 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 (10002217) -10002217 - -
Year 1 3449130 -6553087 3449130 0.8696 2999243
Year 2 3955457 -2597630 7404587 0.7561 2990894
Year 3 3962466 1364836 11367053 0.6575 2605386
Year 4 3240050 4604886 14607103 0.5718 1852509
TOTAL 10448032


The Net NPV after 4 years is 445815

(10448032 - 10002217 )








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 (10002217) -10002217 - -
Year 1 3449130 -6553087 3449130 0.8333 2874275
Year 2 3955457 -2597630 7404587 0.6944 2746845
Year 3 3962466 1364836 11367053 0.5787 2293094
Year 4 3240050 4604886 14607103 0.4823 1562524
TOTAL 9476738


The Net NPV after 4 years is -525479

At 20% discount rate the NPV is negative (9476738 - 10002217 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Nations Inac 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 Nations Inac has a NPV value higher than Zero then finance managers at Nations Inac 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 Nations Inac, then the stock price of the Nations Inac 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 Nations Inac 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 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.

What can impact the cash flow of 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.

Understanding of risks involved in the project.

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 Indian and Northern Affairs Canada - The New Horizon Farms Dilemma

References & Further Readings

David Sparling, Steven Koeckhoven (2018), "Indian and Northern Affairs Canada - The New Horizon Farms Dilemma Harvard Business Review Case Study. Published by HBR Publications.


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