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Apollo Hospitals: Differentiation through Hospitality 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 Apollo Hospitals: Differentiation through Hospitality case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Apollo Hospitals: Differentiation through Hospitality case study is a Harvard Business School (HBR) case study written by Suhruta Kulkarni, Kripa Makhija, Unnikrishnan Dinesh Kumar. The Apollo Hospitals: Differentiation through Hospitality (referred as “Complaints 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, .

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 Apollo Hospitals: Differentiation through Hospitality Case Study


Dr. Ananth Rao, who heads the Quality Department at Apollo Hospitals, Bangalore, had undertaken initiatives to measure and benchmark the hospitality services at the hospital. In-patients spend around 80% of their time under the care of the staff from different departments such as nursing, housekeeping, food & beverages, operations, and so on. The Quality team at Apollo Bangalore received 1,434 complaints from the 1,38,600 in-patients treated between March 2011 and December 2012. The feedback was generally open-ended, in the form of patients' comments, opinions, or suggestions. Of the 1,434 complaints received, the housekeeping department received the maximum number of complaints, while the dietary service had the least number. Some of the complaints were genuine concerns, while some were related to minor discomfort. Some of the complaints were very specific, while some were generic. All of these were analyzed, which would enable the hospital to work towards reducing the overall number of complaints. Text analytics was used to analyze the open-ended complaints. In order to gain deeper insights, "Defect-Defective" techniques were used to identify the processes that caused the defects. The processes were re-engineered to eliminate all the defects and a pilot study was done using the "Define Measure Analyse Improve and Control" (DMAIC) cycle. Dr. Rao and his team have developed benchmarks for several common complaints with three levels of service by adopting the Kano model. Critical to Quality (CTQ) metrics have been defined and Sigma levels were calculated for each CTQ. Dr Rao is pondering on what is a good Sigma score target to set given the importance of hospitality in Apollo Hospitals.


Case Authors : Suhruta Kulkarni, Kripa Makhija, Unnikrishnan Dinesh Kumar

Topic : Technology & Operations

Related Areas :




Calculating Net Present Value (NPV) at 6% for Apollo Hospitals: Differentiation through Hospitality Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10001218) -10001218 - -
Year 1 3469647 -6531571 3469647 0.9434 3273252
Year 2 3961786 -2569785 7431433 0.89 3525975
Year 3 3938143 1368358 11369576 0.8396 3306541
Year 4 3248941 4617299 14618517 0.7921 2573466
TOTAL 14618517 12679234




The Net Present Value at 6% discount rate is 2678016

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. Profitability Index
2. Net Present Value
3. Payback Period
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Complaints 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 Complaints 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.






Formula and Steps to Calculate Net Present Value (NPV) of Apollo Hospitals: Differentiation through Hospitality

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 Complaints 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 Complaints 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 (10001218) -10001218 - -
Year 1 3469647 -6531571 3469647 0.8696 3017084
Year 2 3961786 -2569785 7431433 0.7561 2995679
Year 3 3938143 1368358 11369576 0.6575 2589393
Year 4 3248941 4617299 14618517 0.5718 1857593
TOTAL 10459749


The Net NPV after 4 years is 458531

(10459749 - 10001218 )








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 (10001218) -10001218 - -
Year 1 3469647 -6531571 3469647 0.8333 2891373
Year 2 3961786 -2569785 7431433 0.6944 2751240
Year 3 3938143 1368358 11369576 0.5787 2279018
Year 4 3248941 4617299 14618517 0.4823 1566812
TOTAL 9488443


The Net NPV after 4 years is -512775

At 20% discount rate the NPV is negative (9488443 - 10001218 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Complaints 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 Complaints Apollo has a NPV value higher than Zero then finance managers at Complaints 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 Complaints Apollo, then the stock price of the Complaints 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 Complaints 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 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.

What can impact the cash flow of the project.

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.






Negotiation Strategy of Apollo Hospitals: Differentiation through Hospitality

References & Further Readings

Suhruta Kulkarni, Kripa Makhija, Unnikrishnan Dinesh Kumar (2018), "Apollo Hospitals: Differentiation through Hospitality Harvard Business Review Case Study. Published by HBR Publications.


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