Beef in Brazil: Shrinking Deforestation While Growing the Industry 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 Beef in Brazil: Shrinking Deforestation While Growing the Industry case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Beef in Brazil: Shrinking Deforestation While Growing the Industry case study is a Harvard Business School (HBR) case study written by Hau Lee, Sonali Rammohan. The Beef in Brazil: Shrinking Deforestation While Growing the Industry (referred as “Deforestation Cattle” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Financial markets, Government, Growth strategy, Risk management, 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.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of Beef in Brazil: Shrinking Deforestation While Growing the Industry Case Study

In June 2009, Greenpeace accused the cattle industry of contributing to deforestation in the Brazilian Amazon. Big brands that bought beef and leather were named as silent partners to the practice. Pressure from Greenpeace and the Brazilian government led to major changes. Meatpackers Bertin, JBS, Marfrig, and Minerva, responsible for one-third of exports, agreed to stop purchasing directly and indirectly from ranches that cleared more forest than legally permitted, and committed to buying from direct and indirect suppliers that reduced deforestation to zero. Fernando Sampaio, executive director of Abiec, the Brazilian Beef Exporters Association, worked closely with meatpackers that exported beef to comply with deforestation agreements. While Abiec's mission was to grow the export sector, his members were now asked to take an active role in curbing deforestation. Progress was promising. Deforestation dropped by over 80 percent from 2004 to 2014, attributable in part to the cattle agreements. This was clear progress, since the cattle sector in the Amazon was one of the largest drivers of global deforestation. Yet, traceability of animal movements among farms and slaughterhouses was a big challenge. Some non-compliant ranches were selling to slaughterhouses without full monitoring systems. Other non-compliant ranches were selling cattle into legitimate supply chains through licensed ranches. By mid-2015, Brazilian Amazon deforestation had grown by 16 percent compared to the prior year, demonstrating that gains were fragile. How could Abiec, which represented 29 meatpackers responsible for 70 percent of slaughtering and 93 percent of exports, persuade more members to adopt a zero-deforestation policy and demand supplier compliance? Sampaio's goal of growing sales for his members while curbing deforestation was complex and required working with many beef value chain actors. Industry collaboration, traceability approaches, monitoring efforts, rancher penalties and incentives, productivity improvement efforts, impact investments, and building capabilities of indirect suppliers had produced significant changes. Yet, Abiec needed to influence its smaller members and tackle indirect suppliers - the ones often linked to deforestation. Could cattle-driven deforestation ever be contained?

Case Authors : Hau Lee, Sonali Rammohan

Topic : Leadership & Managing People

Related Areas : Financial markets, Government, Growth strategy, Risk management, Supply chain, Sustainability

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Calculating Net Present Value (NPV) at 6% for Beef in Brazil: Shrinking Deforestation While Growing the Industry Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10023029)	-10023029	-	-
Year 1	3464952	-6558077	3464952	0.9434	3268823
Year 2	3972896	-2585181	7437848	0.89	3535863
Year 3	3969273	1384092	11407121	0.8396	3332678
Year 4	3241922	4626014	14649043	0.7921	2567906
TOTAL			14649043		12705270

The Net Present Value at 6% discount rate is 2682241

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. 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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Deforestation Cattle 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 Deforestation Cattle have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Beef in Brazil: Shrinking Deforestation While Growing the Industry

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 Leadership & Managing People 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 Deforestation Cattle 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 Deforestation Cattle 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	(10023029)	-10023029	-	-
Year 1	3464952	-6558077	3464952	0.8696	3013002
Year 2	3972896	-2585181	7437848	0.7561	3004080
Year 3	3969273	1384092	11407121	0.6575	2609861
Year 4	3241922	4626014	14649043	0.5718	1853579
TOTAL					10480523

The Net NPV after 4 years is 457494

(10480523 - 10023029 )

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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	(10023029)	-10023029	-	-
Year 1	3464952	-6558077	3464952	0.8333	2887460
Year 2	3972896	-2585181	7437848	0.6944	2758956
Year 3	3969273	1384092	11407121	0.5787	2297033
Year 4	3241922	4626014	14649043	0.4823	1563427
TOTAL					9506875

The Net NPV after 4 years is -516154

At 20% discount rate the NPV is negative (9506875 - 10023029 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Deforestation Cattle 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 Deforestation Cattle has a NPV value higher than Zero then finance managers at Deforestation Cattle 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 Deforestation Cattle, then the stock price of the Deforestation Cattle 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 Deforestation Cattle 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 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 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 Beef in Brazil: Shrinking Deforestation While Growing the Industry

References & Further Readings

Hau Lee, Sonali Rammohan (2018), "Beef in Brazil: Shrinking Deforestation While Growing the Industry Harvard Business Review Case Study. Published by HBR Publications.