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India Post 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 India Post case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. India Post case study is a Harvard Business School (HBR) case study written by Arpita Agnihotri, Saurabh Bhattacharya. The India Post (referred as “Post India” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, .

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 India Post Case Study


The advent of the world wide web and the entry of private players in India's post-liberalization era resulted in India Post losing a substantial volume of its business to e-mails, faxes, short-message services and private-courier-service providers. Additionally, government policies regarding India Post had long remained unchanged. As a consequence, India Post was caught up in a vicious cycle of decreasing mail traffic, low levels of technology investment, poor financial performance and poor customer service. Critics also raised questions regarding India Post's lack of market orientation. Nevertheless, India Post responded by taking advantage of its huge distribution network, pursuing related diversification and modernizing its facilities. Despite these efforts, undertaken between 2005 and 2012, India Post was unable to report any profits, although the efforts generated revenue growth. Among all the services that the postal department provided, only postal insurance generated significant profits. It was from this perspective that India Post's management wondered whether it should follow the example of countries like Germany and the Netherlands, where the postal services had been privatized, or whether it should wait for the 2005-2012 initiatives to generate profits for India Post in the coming years.


Case Authors : Arpita Agnihotri, Saurabh Bhattacharya

Topic : Strategy & Execution

Related Areas :




Calculating Net Present Value (NPV) at 6% for India Post Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10021994) -10021994 - -
Year 1 3467127 -6554867 3467127 0.9434 3270875
Year 2 3962844 -2592023 7429971 0.89 3526917
Year 3 3963112 1371089 11393083 0.8396 3327505
Year 4 3224297 4595386 14617380 0.7921 2553945
TOTAL 14617380 12679242


The Net Present Value at 6% discount rate is 2657248

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

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 Post India 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. Post India shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.




Formula and Steps to Calculate Net Present Value (NPV) of India Post

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 Post India 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 Post India 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 (10021994) -10021994 - -
Year 1 3467127 -6554867 3467127 0.8696 3014893
Year 2 3962844 -2592023 7429971 0.7561 2996479
Year 3 3963112 1371089 11393083 0.6575 2605810
Year 4 3224297 4595386 14617380 0.5718 1843502
TOTAL 10460685


The Net NPV after 4 years is 438691

(10460685 - 10021994 )






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 (10021994) -10021994 - -
Year 1 3467127 -6554867 3467127 0.8333 2889273
Year 2 3962844 -2592023 7429971 0.6944 2751975
Year 3 3963112 1371089 11393083 0.5787 2293468
Year 4 3224297 4595386 14617380 0.4823 1554927
TOTAL 9489642


The Net NPV after 4 years is -532352

At 20% discount rate the NPV is negative (9489642 - 10021994 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Post India 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 Post India has a NPV value higher than Zero then finance managers at Post India 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 Post India, then the stock price of the Post India 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 Post India 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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in 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 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.




References & Further Readings

Arpita Agnihotri, Saurabh Bhattacharya (2018), "India Post Harvard Business Review Case Study. Published by HBR Publications.