Adani Agri Logistics Limited: Blocking the Grain Drain 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 Adani Agri Logistics Limited: Blocking the Grain Drain case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Adani Agri Logistics Limited: Blocking the Grain Drain case study is a Harvard Business School (HBR) case study written by Mohita Gangwar, K.N. Singh, Sachinder Mohan Sharma, Puneet Mehndiratta. The Adani Agri Logistics Limited: Blocking the Grain Drain (referred as “Aall Adani” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Leadership, 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 Adani Agri Logistics Limited: Blocking the Grain Drain Case Study

Adani Agri Logistics Limited (AALL) was established to execute a national project for the bulk handling of food grains through a public-private partnership with the Food Corporation of India. This project involved financing, planning, designing, constructing, operating and maintaining modern infrastructure for the bulk handling, storage and transportation of grains required for the public distribution system. Although a technology-driven supply chain solution was implemented, the benefits of this innovative supply system did not come into full fruition even after four years of operation. AALL soon realized that farmers were reluctant to accept the new storage system because it was a departure from the relationship-based transactions they were used to undertaking with traditional intermediaries. In this way, the company learned that there are cultural subtleties and traditions that must be appreciated and given consideration, along with the economic justifications. How could these traditions be respected and upheld while making way for improvement and progress? Author Mohita Gangwar is affiliated with FORE School of Management. Author K.N. Singh is affiliated with the Indian Institute of Management.

Case Authors : Mohita Gangwar, K.N. Singh, Sachinder Mohan Sharma, Puneet Mehndiratta

Topic : Technology & Operations

Related Areas : Leadership, Operations management

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Calculating Net Present Value (NPV) at 6% for Adani Agri Logistics Limited: Blocking the Grain Drain Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016435)	-10016435	-	-
Year 1	3472200	-6544235	3472200	0.9434	3275660
Year 2	3956272	-2587963	7428472	0.89	3521068
Year 3	3938109	1350146	11366581	0.8396	3306512
Year 4	3245061	4595207	14611642	0.7921	2570392
TOTAL			14611642		12673633

The Net Present Value at 6% discount rate is 2657198

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. Profitability Index
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. Timing of the expected cash flows – stockholders of Aall Adani 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. Aall Adani 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 Adani Agri Logistics Limited: Blocking the Grain Drain

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 Aall Adani 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 Aall Adani 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	(10016435)	-10016435	-	-
Year 1	3472200	-6544235	3472200	0.8696	3019304
Year 2	3956272	-2587963	7428472	0.7561	2991510
Year 3	3938109	1350146	11366581	0.6575	2589371
Year 4	3245061	4595207	14611642	0.5718	1855374
TOTAL					10455559

The Net NPV after 4 years is 439124

(10455559 - 10016435 )

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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	(10016435)	-10016435	-	-
Year 1	3472200	-6544235	3472200	0.8333	2893500
Year 2	3956272	-2587963	7428472	0.6944	2747411
Year 3	3938109	1350146	11366581	0.5787	2278998
Year 4	3245061	4595207	14611642	0.4823	1564941
TOTAL					9484850

The Net NPV after 4 years is -531585

At 20% discount rate the NPV is negative (9484850 - 10016435 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Aall Adani 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 Aall Adani has a NPV value higher than Zero then finance managers at Aall Adani 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 Aall Adani, then the stock price of the Aall Adani 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 Aall Adani 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 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.

What will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

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 Adani Agri Logistics Limited: Blocking the Grain Drain

References & Further Readings

Mohita Gangwar, K.N. Singh, Sachinder Mohan Sharma, Puneet Mehndiratta (2018), "Adani Agri Logistics Limited: Blocking the Grain Drain Harvard Business Review Case Study. Published by HBR Publications.