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TELEFA“NICA'S BID FOR THE MOBILE MARKET IN BRAZIL (C) 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 TELEFA“NICA'S BID FOR THE MOBILE MARKET IN BRAZIL (C) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. TELEFA“NICA'S BID FOR THE MOBILE MARKET IN BRAZIL (C) case study is a Harvard Business School (HBR) case study written by Nuno Fernandes. The TELEFA“NICA'S BID FOR THE MOBILE MARKET IN BRAZIL (C) (referred as “Telefa Nica” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Financial management, Joint ventures, Mergers & acquisitions.

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 TELEFA“NICA'S BID FOR THE MOBILE MARKET IN BRAZIL (C) Case Study


Case A of this series sets the scene for the largest merger and acquisition (M&A) deal in the telecom industry in Brazil and Latin America. Cases B to F follow on by relating the events up to the deal's conclusion. The sequencing of this story creates a sense of urgency for readers and forces them to take position on different questions at different times. Events began in 2003 when a 50:50 joint venture (JV) between Portugal Telecom (PT) and Spain's TelefA³nica acquired 60% of Vivo, the leading Brazilian mobile operator. In the subsequent years, Vivo experienced double-digit annual growth, as it reaped the benefits of its own heavy investments and booming consumer demand. In May 2010, TelefA³nica made a a‚¬5.7 billion cash bid for PT's share of the JV. According to TelefA³nica, this was a full, fair and final offer. How would PT's board regard the bid? On the one hand, it represented a 100% premium on Vivo's pre-announcement stock price. On the other hand, it was a terrible blow to the PT Group's international aspirations. Moreover, the occasionally conflicting views of the general public and the government had the potential to complicate matters further. Lastly, this deal also had important international implications. The case shows how: a) corporate governance practices vary across countries, including environments where there are dual-class shares; and b) the role of corporate governance in ensuring that managers undertake activities that maximize shareholder value as well as serving the needs and strategy of the company. The case also allows for an in-depth analysis of a variety of strategic, organizational, financial and economic issues related to growth strategies through JVs and M&As. The key focus of the case is on the links between finance and strategy.


Case Authors : Nuno Fernandes

Topic : Finance & Accounting

Related Areas : Financial management, Joint ventures, Mergers & acquisitions




Calculating Net Present Value (NPV) at 6% for TELEFA“NICA'S BID FOR THE MOBILE MARKET IN BRAZIL (C) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10023532) -10023532 - -
Year 1 3454618 -6568914 3454618 0.9434 3259074
Year 2 3957046 -2611868 7411664 0.89 3521757
Year 3 3937870 1326002 11349534 0.8396 3306312
Year 4 3245265 4571267 14594799 0.7921 2570554
TOTAL 14594799 12657696




The Net Present Value at 6% discount rate is 2634164

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. Internal Rate of Return
3. Profitability Index
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 Telefa Nica 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. Telefa Nica 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 TELEFA“NICA'S BID FOR THE MOBILE MARKET IN BRAZIL (C)

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 Finance & Accounting 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 Telefa Nica 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 Telefa Nica 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 (10023532) -10023532 - -
Year 1 3454618 -6568914 3454618 0.8696 3004016
Year 2 3957046 -2611868 7411664 0.7561 2992095
Year 3 3937870 1326002 11349534 0.6575 2589213
Year 4 3245265 4571267 14594799 0.5718 1855491
TOTAL 10440815


The Net NPV after 4 years is 417283

(10440815 - 10023532 )








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 (10023532) -10023532 - -
Year 1 3454618 -6568914 3454618 0.8333 2878848
Year 2 3957046 -2611868 7411664 0.6944 2747949
Year 3 3937870 1326002 11349534 0.5787 2278860
Year 4 3245265 4571267 14594799 0.4823 1565039
TOTAL 9470696


The Net NPV after 4 years is -552836

At 20% discount rate the NPV is negative (9470696 - 10023532 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Telefa Nica 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 Telefa Nica has a NPV value higher than Zero then finance managers at Telefa Nica 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 Telefa Nica, then the stock price of the Telefa Nica 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 Telefa Nica 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.

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 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.






Negotiation Strategy of TELEFA“NICA'S BID FOR THE MOBILE MARKET IN BRAZIL (C)

References & Further Readings

Nuno Fernandes (2018), "TELEFA“NICA'S BID FOR THE MOBILE MARKET IN BRAZIL (C) Harvard Business Review Case Study. Published by HBR Publications.


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