Taiwan's High-Speed Rail: A Public-Private Partnership Hits a Speed Bump 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 Taiwan's High-Speed Rail: A Public-Private Partnership Hits a Speed Bump case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Taiwan's High-Speed Rail: A Public-Private Partnership Hits a Speed Bump case study is a Harvard Business School (HBR) case study written by Chung-Yuang Jan, Steve Kelman. The Taiwan's High-Speed Rail: A Public-Private Partnership Hits a Speed Bump (referred as “Taiwan's Thsrc” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Economy, Financial management, Government, Human resource management, International business, Joint ventures.

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 Taiwan's High-Speed Rail: A Public-Private Partnership Hits a Speed Bump Case Study

This case traces the evolution of Taiwan's high-speed railroad from project inception in the late 1980s until its financial problems in 2009 describing the planning efforts, ridership projections, financial plans and cost-benefit analysis involved in the project, as well as the contracting process for the project. This project was one of the largest infrastructure projects in the world and one of the largest infrastructure projects ever built, using a "public-private partnership" (PPP) - a method for infrastructure development where the private sector would build and operate a project for several decades and then transfer ownership to the government. However, in 2009, after only two years of operation, Taiwan High Speed Rail Corporation (THSRC), the private consortium responsible for building and operating the high-speed rail system, was in deep financial trouble due to low ridership and the worldwide economic crisis. Unable to pay back the principal on its bank loans, the President of THSRC requested a meeting with Taiwan's Minister of Transportation and Communications asking to hand the railroad over to the government to run. THSRC requested that compensation be set by an independent third party, as provided for in the event of a government takeover in the government's original contract with the company. Readers are left with the question of what Taiwan's Minister of Transportation and Communications should do in response to THSRC's request. The case can be used in class discussions on the management of public-private partnerships, government procurement/contracting, and on decision-making. HKS Case Number 1910.0

Case Authors : Chung-Yuang Jan, Steve Kelman

Topic : Strategy & Execution

Related Areas : Economy, Financial management, Government, Human resource management, International business, Joint ventures

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Calculating Net Present Value (NPV) at 6% for Taiwan's High-Speed Rail: A Public-Private Partnership Hits a Speed Bump Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10014296)	-10014296	-	-
Year 1	3454036	-6560260	3454036	0.9434	3258525
Year 2	3960734	-2599526	7414770	0.89	3525039
Year 3	3956073	1356547	11370843	0.8396	3321595
Year 4	3248071	4604618	14618914	0.7921	2572776
TOTAL			14618914		12677935

The Net Present Value at 6% discount rate is 2663639

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. Profitability Index
2. Payback Period
3. Net Present Value
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. Timing of the expected cash flows – stockholders of Taiwan's Thsrc have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Taiwan's Thsrc shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Taiwan's High-Speed Rail: A Public-Private Partnership Hits a Speed Bump

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 Taiwan's Thsrc 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 Taiwan's Thsrc 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	(10014296)	-10014296	-	-
Year 1	3454036	-6560260	3454036	0.8696	3003510
Year 2	3960734	-2599526	7414770	0.7561	2994884
Year 3	3956073	1356547	11370843	0.6575	2601182
Year 4	3248071	4604618	14618914	0.5718	1857095
TOTAL					10456671

The Net NPV after 4 years is 442375

(10456671 - 10014296 )

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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	(10014296)	-10014296	-	-
Year 1	3454036	-6560260	3454036	0.8333	2878363
Year 2	3960734	-2599526	7414770	0.6944	2750510
Year 3	3956073	1356547	11370843	0.5787	2289394
Year 4	3248071	4604618	14618914	0.4823	1566392
TOTAL					9484659

The Net NPV after 4 years is -529637

At 20% discount rate the NPV is negative (9484659 - 10014296 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Taiwan's Thsrc 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 Taiwan's Thsrc has a NPV value higher than Zero then finance managers at Taiwan's Thsrc 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 Taiwan's Thsrc, then the stock price of the Taiwan's Thsrc 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 Taiwan's Thsrc 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 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.

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.

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 Taiwan's High-Speed Rail: A Public-Private Partnership Hits a Speed Bump

References & Further Readings

Chung-Yuang Jan, Steve Kelman (2018), "Taiwan's High-Speed Rail: A Public-Private Partnership Hits a Speed Bump Harvard Business Review Case Study. Published by HBR Publications.