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Entrepreneurship and IT Complementarity: The Case of People's Remittance and Exchange Services 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 Entrepreneurship and IT Complementarity: The Case of People's Remittance and Exchange Services case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Entrepreneurship and IT Complementarity: The Case of People's Remittance and Exchange Services case study is a Harvard Business School (HBR) case study written by Probir Kumar Banerjee, Moez Limayem, Louis Ma. The Entrepreneurship and IT Complementarity: The Case of People's Remittance and Exchange Services (referred as “Remittance People's” 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, Technology.

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 Entrepreneurship and IT Complementarity: The Case of People's Remittance and Exchange Services Case Study


Mr. Rao, with several years of banking experience, approached People's Group Dubai, a venture capitalist firm, seeking financing for a micro-remittance-cum-foreign exchange service operation in Hong Kong. He argued that demand for currency exchange services in Hong Kong would continue to grow because of the high number of tourists who visited Hong Kong on their China tour. He also argued that a captive market of domestic workers who remitted their wages to their home countries would provide continuous demand for remittance services. Mr. Rao was confident that he could start quickly with a small office staffed by a few tellers and one manager in a busy location of Hong Kong, and then expand operations to other locations. However, financing to cover fixed assets and working capital would be required to open additional outlets. A major enabler of the proposed strategy was the telecommunication network of Western Union, which had established a presence in several parts of the world as a trustworthy provider of remittance services. Mr. Rao also intended to benefit from the technology support and expertise of the IT arm of People's Group based in Bangalore, India. People's Group Dubai welcomed realistic entrepreneurial ideas if they were backed by clear strategies for business growth and promised an acceptable rate of return on investment (ROI). With competition and low-cost micro-remittance services provided by pure Internet players, there were questions about the adequacy of technology support from the Bangalore arm in steering Mr. Rao's proposed venture to success and generating adequate ROI in the short and long run. People's Group directors debated the viability of the proposed venture.


Case Authors : Probir Kumar Banerjee, Moez Limayem, Louis Ma

Topic : Technology & Operations

Related Areas : Entrepreneurship, Technology




Calculating Net Present Value (NPV) at 6% for Entrepreneurship and IT Complementarity: The Case of People's Remittance and Exchange Services Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10005941) -10005941 - -
Year 1 3470818 -6535123 3470818 0.9434 3274357
Year 2 3965086 -2570037 7435904 0.89 3528912
Year 3 3951529 1381492 11387433 0.8396 3317780
Year 4 3247230 4628722 14634663 0.7921 2572110
TOTAL 14634663 12693159


The Net Present Value at 6% discount rate is 2687218

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. Internal Rate of Return
2. Profitability Index
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. Remittance People's 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 Remittance People's 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 Entrepreneurship and IT Complementarity: The Case of People's Remittance and Exchange Services

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 Remittance People's 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 Remittance People's 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 (10005941) -10005941 - -
Year 1 3470818 -6535123 3470818 0.8696 3018103
Year 2 3965086 -2570037 7435904 0.7561 2998175
Year 3 3951529 1381492 11387433 0.6575 2598194
Year 4 3247230 4628722 14634663 0.5718 1856614
TOTAL 10471086


The Net NPV after 4 years is 465145

(10471086 - 10005941 )






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 (10005941) -10005941 - -
Year 1 3470818 -6535123 3470818 0.8333 2892348
Year 2 3965086 -2570037 7435904 0.6944 2753532
Year 3 3951529 1381492 11387433 0.5787 2286764
Year 4 3247230 4628722 14634663 0.4823 1565987
TOTAL 9498631


The Net NPV after 4 years is -507310

At 20% discount rate the NPV is negative (9498631 - 10005941 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Remittance People's 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 Remittance People's has a NPV value higher than Zero then finance managers at Remittance People's 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 Remittance People's, then the stock price of the Remittance People's 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 Remittance People's 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 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.

What can impact the cash flow of 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 will be a multi year spillover effect of various taxation regulations.

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

Probir Kumar Banerjee, Moez Limayem, Louis Ma (2018), "Entrepreneurship and IT Complementarity: The Case of People's Remittance and Exchange Services Harvard Business Review Case Study. Published by HBR Publications.