Forecasting Demand for Food at Apollo Hospitals 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 Forecasting Demand for Food at Apollo Hospitals case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Forecasting Demand for Food at Apollo Hospitals case study is a Harvard Business School (HBR) case study written by Sujoy Roychowdhury, Alok Shrivastava, Dinesh Kumar Unnikrishnan. The Forecasting Demand for Food at Apollo Hospitals (referred as “Food Apollo” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, 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 Forecasting Demand for Food at Apollo Hospitals Case Study

Established in 1983, Apollo Hospitals is one of India's largest hospital chains. In 2014, Apollo had 32 hospitals spread across the country. The focus of this case is of the Apollo Hospital at Bangalore. The quality head, Dr. Ananth Rao was worried about the food bill that accounted for 4% of the total cost and wanted to develop a forecasting model to estimate the demand for food and beverages being served to its patients for breakfast, lunch, and dinner. Accurate forecasting will help them to minimize the wastage of food resulting in reduction of food bill. Apollo served approximately 120 food items from its kitchen. Dr Rao believed that the demand for food was dependent on the occupancy level (number of in-patients) of the hospital. Moreover, he also expected a short-term trend in the food requirement because patients are likely to order similar food during their course of stay in the hospital - this is because of dietary restrictions as also the fact that people would generally not wish to experiment with food in a hospital environment. The profile of the patients in the hospital is unlikely to vary significantly over a period of time and so it is expected that the food trend will not change much with time.

Case Authors : Sujoy Roychowdhury, Alok Shrivastava, Dinesh Kumar Unnikrishnan

Topic : Technology & Operations

Related Areas : Operations management

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Calculating Net Present Value (NPV) at 6% for Forecasting Demand for Food at Apollo Hospitals Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019028)	-10019028	-	-
Year 1	3471867	-6547161	3471867	0.9434	3275346
Year 2	3953169	-2593992	7425036	0.89	3518306
Year 3	3941259	1347267	11366295	0.8396	3309157
Year 4	3249885	4597152	14616180	0.7921	2574213
TOTAL			14616180		12677023

The Net Present Value at 6% discount rate is 2657995

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. Net Present Value
3. Internal Rate of Return
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. Food Apollo 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 Food Apollo have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Forecasting Demand for Food at Apollo Hospitals

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 Food Apollo 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 Food Apollo 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	(10019028)	-10019028	-	-
Year 1	3471867	-6547161	3471867	0.8696	3019015
Year 2	3953169	-2593992	7425036	0.7561	2989164
Year 3	3941259	1347267	11366295	0.6575	2591442
Year 4	3249885	4597152	14616180	0.5718	1858132
TOTAL					10457753

The Net NPV after 4 years is 438725

(10457753 - 10019028 )

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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	(10019028)	-10019028	-	-
Year 1	3471867	-6547161	3471867	0.8333	2893223
Year 2	3953169	-2593992	7425036	0.6944	2745256
Year 3	3941259	1347267	11366295	0.5787	2280821
Year 4	3249885	4597152	14616180	0.4823	1567267
TOTAL					9486567

The Net NPV after 4 years is -532461

At 20% discount rate the NPV is negative (9486567 - 10019028 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Food Apollo 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 Food Apollo has a NPV value higher than Zero then finance managers at Food Apollo 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 Food Apollo, then the stock price of the Food Apollo 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 Food Apollo 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.

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.

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 Forecasting Demand for Food at Apollo Hospitals

References & Further Readings

Sujoy Roychowdhury, Alok Shrivastava, Dinesh Kumar Unnikrishnan (2018), "Forecasting Demand for Food at Apollo Hospitals Harvard Business Review Case Study. Published by HBR Publications.