Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?
At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Haiti Hope: Innovating the Mango Value Chain case study is a Harvard Business School (HBR) case study written by Amy C. Edmondson, Jean-Francois Harvey. The Haiti Hope: Innovating the Mango Value Chain (referred as “Farmers Pbgs” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Economic development, Emerging markets, Social enterprise, Social responsibility, Strategy execution, Supply chain, Sustainability.
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.
This case study examines a market-based approach to economic development through the eyes of NGO TechnoServe's project manager, implementing a US$9.5 five-year public-private partnership between Coca-Cola, IDB, and USAID. The case ends at the beginning of the final year of the project, presents the project's advances, and invites students to position themselves in front of three options regarding the exit strategy to be deployed to ensure sustainability.Haiti Hope was to provide 25,000 Haitian farmers with world-class business and industry expertise to help them grow mangos more efficiently and abundantly, and secure access to new markets with the aim of doubling their income and raising their standard of living and, ultimately, contributing to the revitalization of the Haitian economy. The project structure devised by the partners to govern execution consisted of an implementation team and operating and steering committees. The partners with the implementer, TechnoServe, had agreed on a strategy that turned out to be difficult to execute due to local institutions, farmer cooperatives, which acted as gatekeepers and made it difficult to reach the critical mass of farmers to participate in the project. TechnoServe's project manager had to convince the partners to shift strategy to work directly with cooperative members rather than with the leadership. The project manager succeeded - Partners accepted to create a new intermediary channel with and for smallholder farmers, termed Producer Business Groups (PBGs). PBGs eschewed the diverse political goals of most cooperatives, and focused on the production and commercialization of members' mangoes and other agricultural products. By 2013, 18,000 farmers had been organized into PBGs for better access to markets, information and agricultural extension services, and approximately 70% of them had adopted best practices from training. Project trained farmers were earning higher prices for mangoes, which rose by 32% on average. By 2014, 3,356 of these farmers were selling directly to exporters via this new PBG channel. With the project entering its final year of implementation, only one season remained for course corrections and formulation of an exit strategy that ensured that every player was profitable, and that local actors possessed both the motivation and capability to take over the activities being performed by TechnoServe.
| Years | Cash Flow | Net Cash Flow | Cumulative Cash Flow |
Discount Rate @ 6 % |
Discounted Cash Flows |
|---|---|---|---|---|---|
| Year 0 | (10006912) | -10006912 | - | - | |
| Year 1 | 3457269 | -6549643 | 3457269 | 0.9434 | 3261575 |
| Year 2 | 3962639 | -2587004 | 7419908 | 0.89 | 3526735 |
| Year 3 | 3952739 | 1365735 | 11372647 | 0.8396 | 3318796 |
| Year 4 | 3222716 | 4588451 | 14595363 | 0.7921 | 2552693 |
| TOTAL | 14595363 | 12659798 |
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 -
Capital Budgeting Approaches
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. Payback Period
4. Net Present Value
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 Farmers Pbgs 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. Farmers Pbgs shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
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
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 Farmers Pbgs 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 Farmers Pbgs 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.
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 | (10006912) | -10006912 | - | - | |
| Year 1 | 3457269 | -6549643 | 3457269 | 0.8696 | 3006321 |
| Year 2 | 3962639 | -2587004 | 7419908 | 0.7561 | 2996324 |
| Year 3 | 3952739 | 1365735 | 11372647 | 0.6575 | 2598990 |
| Year 4 | 3222716 | 4588451 | 14595363 | 0.5718 | 1842598 |
| TOTAL | 10444234 |
(10444234 - 10006912 )
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 | (10006912) | -10006912 | - | - | |
| Year 1 | 3457269 | -6549643 | 3457269 | 0.8333 | 2881058 |
| Year 2 | 3962639 | -2587004 | 7419908 | 0.6944 | 2751833 |
| Year 3 | 3952739 | 1365735 | 11372647 | 0.5787 | 2287465 |
| Year 4 | 3222716 | 4588451 | 14595363 | 0.4823 | 1554165 |
| TOTAL | 9474520 |
At 20% discount rate the NPV is negative (9474520 - 10006912 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Farmers Pbgs to discount cash flow at lower discount rates such as 15%.
Simplest Approach – If the investment project of Farmers Pbgs has a NPV value higher than Zero then finance managers at Farmers Pbgs 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 Farmers Pbgs, then the stock price of the Farmers Pbgs 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.
Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Farmers Pbgs 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.
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.
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.
Amy C. Edmondson, Jean-Francois Harvey (2018), "Haiti Hope: Innovating the Mango Value Chain Harvard Business Review Case Study. Published by HBR Publications.
Feel free to connect with us if you need business research.
You can download Excel Template of Case Study Solution & Analysis of Haiti Hope: Innovating the Mango Value Chain
Financial , Misc. Financial Services
Services , Hotels & Motels
Healthcare , Healthcare Facilities
Energy , Oil Well Services & Equipment
Capital Goods , Misc. Capital Goods
Basic Materials , Containers & Packaging
Basic Materials , Gold & Silver
Basic Materials , Metal Mining
Services , Retail (Technology)