VidaGas: VillageReach - The Mozambican Foundation for Community Development Joint Venture 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 VidaGas: VillageReach - The Mozambican Foundation for Community Development Joint Venture case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. VidaGas: VillageReach - The Mozambican Foundation for Community Development Joint Venture case study is a Harvard Business School (HBR) case study written by Noel Watson, Santiago Kraiselburd. The VidaGas: VillageReach - The Mozambican Foundation for Community Development Joint Venture (referred as “Villagereach Lpg” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Entrepreneurship, Financial management, Operations management.

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 VidaGas: VillageReach - The Mozambican Foundation for Community Development Joint Venture Case Study

Subjects Covered: Healthcare, Supply Chain, Developing Countries, Venture CapitalThis case describes the evolution of a liquid petroleum gas (LPG) distributor start-up, incubated by two not-for-profit NGOs to help improve the vaccine cold chain in Northern Mozambique. These NGOs must face the decision whether and how to sell their participation in the start-up. VillageReach and the Mozambican Foundation for Community Development (FDC), both NGOs, got involved in the national immunization program, the Expanded Program on Immunization (EPI), in northern Mozambique. This program's goal was to ensure prompt and universal access to vaccines and other medical supplies. Early on, VillageReach had realized that the program's goals could not be satisfied unless cold storage (and transportation) of the vaccines was guaranteed. Because electricity was scarce and unreliable in the region, VillageReach searched for alternative solutions for supporting cold storage. VillageReach finally decided to use LPG powered refrigerators, and, due to the lack of reliable sources of LPG in the region, FDC and VillageReach went on to fund VidaGas, an LPG distribution company. It soon became evident that an efficient distribution network of LPG could provide benefits to society above and beyond health: at the time, most businesses and households in the region cooked using biomass fuels. Such fuels are a significant health hazard, and also contribute to deforestation in the region. Although VidaGas could be considered a success, it had yet to reach breakeven in its current operations. In addition, new investments would be required to expand operations to neighboring provinces beyond the province used for the pilot, Cabo Delgado. As the Ministry of Health (MoH), FDC and VillageReach are planning to expand the improvements in the national immunization program to these provinces, the presence of a reliable source of LPG would be essential to their goals. At the same time, VillageReach and FDC's resources for further investment are limited.

Case Authors : Noel Watson, Santiago Kraiselburd

Topic : Technology & Operations

Related Areas : Entrepreneurship, Financial management, Operations management

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Calculating Net Present Value (NPV) at 6% for VidaGas: VillageReach - The Mozambican Foundation for Community Development Joint Venture Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016123)	-10016123	-	-
Year 1	3470618	-6545505	3470618	0.9434	3274168
Year 2	3969067	-2576438	7439685	0.89	3532456
Year 3	3955736	1379298	11395421	0.8396	3321312
Year 4	3236073	4615371	14631494	0.7921	2563273
TOTAL			14631494		12691209

The Net Present Value at 6% discount rate is 2675086

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. Net Present Value
2. Payback Period
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. Timing of the expected cash flows – stockholders of Villagereach Lpg 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. Villagereach Lpg 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 VidaGas: VillageReach - The Mozambican Foundation for Community Development Joint Venture

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 Technology & Operations 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 Villagereach Lpg 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 Villagereach Lpg 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	(10016123)	-10016123	-	-
Year 1	3470618	-6545505	3470618	0.8696	3017929
Year 2	3969067	-2576438	7439685	0.7561	3001185
Year 3	3955736	1379298	11395421	0.6575	2600961
Year 4	3236073	4615371	14631494	0.5718	1850235
TOTAL					10470309

The Net NPV after 4 years is 454186

(10470309 - 10016123 )

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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	(10016123)	-10016123	-	-
Year 1	3470618	-6545505	3470618	0.8333	2892182
Year 2	3969067	-2576438	7439685	0.6944	2756297
Year 3	3955736	1379298	11395421	0.5787	2289199
Year 4	3236073	4615371	14631494	0.4823	1560606
TOTAL					9498283

The Net NPV after 4 years is -517840

At 20% discount rate the NPV is negative (9498283 - 10016123 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Villagereach Lpg 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 Villagereach Lpg has a NPV value higher than Zero then finance managers at Villagereach Lpg 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 Villagereach Lpg, then the stock price of the Villagereach Lpg 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 Villagereach Lpg 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 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 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.

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 VidaGas: VillageReach - The Mozambican Foundation for Community Development Joint Venture

References & Further Readings

Noel Watson, Santiago Kraiselburd (2018), "VidaGas: VillageReach - The Mozambican Foundation for Community Development Joint Venture Harvard Business Review Case Study. Published by HBR Publications.