Indian Rupee Crisis of 2013 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 Indian Rupee Crisis of 2013 case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Indian Rupee Crisis of 2013 case study is a Harvard Business School (HBR) case study written by Ganesh Kumar Nidugala, Rashmi Shukla, Romel Mostafa. The Indian Rupee Crisis of 2013 (referred as “Rupee Inflation” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Emerging markets, Recession.

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 Indian Rupee Crisis of 2013 Case Study

The U.S. Federal Reserve System's decision to taper its quantitative easing program triggered large capital outflows from India, and the rupee depreciated by 13.7 per cent from June to August of 2013. Firms dependent on imports complained of rising costs, but exporters stood to benefit from the depreciation. On a macro level, economic growth dropped and inflation remained high, raising concerns that the much-touted "India growth story" was over. India's central bank, the Reserve Bank of India, faced the difficult task of fighting inflation and stopping the rupee's decline once the economic growth had slowed down. Expectations were high for an appropriate action from the bank, even as room for policy maneuverability appeared limited.

Case Authors : Ganesh Kumar Nidugala, Rashmi Shukla, Romel Mostafa

Topic : Finance & Accounting

Related Areas : Emerging markets, Recession

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Calculating Net Present Value (NPV) at 6% for Indian Rupee Crisis of 2013 Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10021163)	-10021163	-	-
Year 1	3459387	-6561776	3459387	0.9434	3263573
Year 2	3980386	-2581390	7439773	0.89	3542529
Year 3	3963157	1381767	11402930	0.8396	3327543
Year 4	3251175	4632942	14654105	0.7921	2575235
TOTAL			14654105		12708880

The Net Present Value at 6% discount rate is 2687717

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 Rupee Inflation 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. Rupee Inflation 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 Indian Rupee Crisis of 2013

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 Rupee Inflation 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 Rupee Inflation 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	(10021163)	-10021163	-	-
Year 1	3459387	-6561776	3459387	0.8696	3008163
Year 2	3980386	-2581390	7439773	0.7561	3009744
Year 3	3963157	1381767	11402930	0.6575	2605840
Year 4	3251175	4632942	14654105	0.5718	1858870
TOTAL					10482616

The Net NPV after 4 years is 461453

(10482616 - 10021163 )

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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	(10021163)	-10021163	-	-
Year 1	3459387	-6561776	3459387	0.8333	2882823
Year 2	3980386	-2581390	7439773	0.6944	2764157
Year 3	3963157	1381767	11402930	0.5787	2293494
Year 4	3251175	4632942	14654105	0.4823	1567889
TOTAL					9508362

The Net NPV after 4 years is -512801

At 20% discount rate the NPV is negative (9508362 - 10021163 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Rupee Inflation 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 Rupee Inflation has a NPV value higher than Zero then finance managers at Rupee Inflation 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 Rupee Inflation, then the stock price of the Rupee Inflation 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 Rupee Inflation 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 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.

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.

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 Indian Rupee Crisis of 2013

References & Further Readings

Ganesh Kumar Nidugala, Rashmi Shukla, Romel Mostafa (2018), "Indian Rupee Crisis of 2013 Harvard Business Review Case Study. Published by HBR Publications.