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GMR Airport Concession: Mumbai Versus Delhi 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 GMR Airport Concession: Mumbai Versus Delhi case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. GMR Airport Concession: Mumbai Versus Delhi case study is a Harvard Business School (HBR) case study written by Abhilash Nair, Rajesh Srinivas Upadhyayula. The GMR Airport Concession: Mumbai Versus Delhi (referred as “Airport Gmr” 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 markets, International business, Organizational culture, Strategy.

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 GMR Airport Concession: Mumbai Versus Delhi Case Study


In 2004, bids were invited from airport developers and operators for the development and operation of Mumbai's Chattrapati Shivaji International Airport and Delhi's Indira Gandhi International Airport. On January 31, 2006, a consortium led by GMR Group (GMR) was selected as the only technically qualified bidder. However, in order to avoid a monopoly in Indian airport operations, GMR was asked to choose between the two airports and match the financial bid of another bidder that was not technically qualified for the work. The Delhi airport, the pride of the National Capital Region, would serve as a gateway for participants, dignitaries, and other guests arriving for the upcoming Commonwealth Games to be held in New Delhi in October 2010. However, the Mumbai airport was the gateway to business investments in India. GMR faced a difficult choice between a mission-critical airport in the National Capital Region or an airport in India's commercial capital. Which airport would give GMR an edge in the global aviation sector? Which choice was in line with GMR's vision? Abhilash Nair is affiliated with Indian Institute of Management Kozhikode. Rajesh Srinivas Upadhyayula is affiliated with Indian Institute of Management Kozhikode.


Case Authors : Abhilash Nair, Rajesh Srinivas Upadhyayula

Topic : Finance & Accounting

Related Areas : Financial markets, International business, Organizational culture, Strategy




Calculating Net Present Value (NPV) at 6% for GMR Airport Concession: Mumbai Versus Delhi Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10005858) -10005858 - -
Year 1 3446441 -6559417 3446441 0.9434 3251359
Year 2 3970762 -2588655 7417203 0.89 3533964
Year 3 3973350 1384695 11390553 0.8396 3336101
Year 4 3231112 4615807 14621665 0.7921 2559343
TOTAL 14621665 12680768


The Net Present Value at 6% discount rate is 2674910

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

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 Airport Gmr 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. Airport Gmr 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 GMR Airport Concession: Mumbai Versus Delhi

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 Airport Gmr 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 Airport Gmr 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 (10005858) -10005858 - -
Year 1 3446441 -6559417 3446441 0.8696 2996905
Year 2 3970762 -2588655 7417203 0.7561 3002467
Year 3 3973350 1384695 11390553 0.6575 2612542
Year 4 3231112 4615807 14621665 0.5718 1847399
TOTAL 10459313


The Net NPV after 4 years is 453455

(10459313 - 10005858 )






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 (10005858) -10005858 - -
Year 1 3446441 -6559417 3446441 0.8333 2872034
Year 2 3970762 -2588655 7417203 0.6944 2757474
Year 3 3973350 1384695 11390553 0.5787 2299392
Year 4 3231112 4615807 14621665 0.4823 1558214
TOTAL 9487114


The Net NPV after 4 years is -518744

At 20% discount rate the NPV is negative (9487114 - 10005858 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Airport Gmr 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 Airport Gmr has a NPV value higher than Zero then finance managers at Airport Gmr 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 Airport Gmr, then the stock price of the Airport Gmr 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 Airport Gmr 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.

What can impact the cash flow of the project.

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.

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

Abhilash Nair, Rajesh Srinivas Upadhyayula (2018), "GMR Airport Concession: Mumbai Versus Delhi Harvard Business Review Case Study. Published by HBR Publications.