Mastering the Make-in-India Challenge 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 Mastering the Make-in-India Challenge case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Mastering the Make-in-India Challenge case study is a Harvard Business School (HBR) case study written by Haritha Saranga, Ram Mudambi, Andreas Schotter. The Mastering the Make-in-India Challenge (referred as “Foreign India” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Supply chain.

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 Mastering the Make-in-India Challenge Case Study

This is an MIT Sloan Management Review article. Despite India's economic growth and potential, developing a successful strategy for the country remains one of the most complex challenges for foreign multinationals. This challenge is rooted in the hard realities of global scale and costs. Most foreign executives have found it difficult to make money in India with their existing product portfolios at the scale of operations dictated by local demand. In addition, India has not provided foreign direct investment incentives anywhere near those of neighboring China. However, U.S. management consulting firm A.T. Kearney estimated in 2014 that India's share of global trade would be approximately five times greater by 2025 -and at that point would represent 6% of all global trade. Given that growth projection, waiting for a target income segment to reach the break-even level or waiting for greater government incentives to materialize is not the right strategy. Indeed, the authors observe, many foreign multinationals have increased their focus on India. However, they add, many foreign executives are frustrated that they cannot replicate the same strategies in India that led to success in China. One reason is the local high-income segment, which constitutes the initial target market for most foreign companies, is relatively small in India compared with China. This often causes foreign executives to refrain from investing in more extensive value-chain activities in India and delay committing to local manufacturing. Based on their research, the authors present a framework for foreign multinationals for a successful first-time entry into India or for upgrading an existing operation in India that has not been very effective. This approach involves simultaneously taking advantage of local sourcing, manufacturing, and marketing activities in conjunction with local adaptation of global products to generate mutually reinforcing advantages. Foreign manufacturers in India, the authors argue, can use both globally focused assets to improve local sales and locally developed capabilities to deliver more cost-effective solutions for global markets. This combination enables companies to reach across all of India's income segments, while at the same time developing a springboard for global exports.

Case Authors : Haritha Saranga, Ram Mudambi, Andreas Schotter

Topic : Global Business

Related Areas : Supply chain

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Calculating Net Present Value (NPV) at 6% for Mastering the Make-in-India Challenge Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10001766)	-10001766	-	-
Year 1	3451270	-6550496	3451270	0.9434	3255915
Year 2	3979813	-2570683	7431083	0.89	3542019
Year 3	3952093	1381410	11383176	0.8396	3318253
Year 4	3225436	4606846	14608612	0.7921	2554847
TOTAL			14608612		12671035

The Net Present Value at 6% discount rate is 2669269

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. Payback Period
2. Profitability Index
3. Internal Rate of Return
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. Foreign India 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 Foreign India 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 Mastering the Make-in-India Challenge

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 Global Business 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 Foreign India 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 Foreign India 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	(10001766)	-10001766	-	-
Year 1	3451270	-6550496	3451270	0.8696	3001104
Year 2	3979813	-2570683	7431083	0.7561	3009310
Year 3	3952093	1381410	11383176	0.6575	2598565
Year 4	3225436	4606846	14608612	0.5718	1844154
TOTAL					10453134

The Net NPV after 4 years is 451368

(10453134 - 10001766 )

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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	(10001766)	-10001766	-	-
Year 1	3451270	-6550496	3451270	0.8333	2876058
Year 2	3979813	-2570683	7431083	0.6944	2763759
Year 3	3952093	1381410	11383176	0.5787	2287091
Year 4	3225436	4606846	14608612	0.4823	1555476
TOTAL					9482385

The Net NPV after 4 years is -519381

At 20% discount rate the NPV is negative (9482385 - 10001766 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Foreign India 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 Foreign India has a NPV value higher than Zero then finance managers at Foreign India 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 Foreign India, then the stock price of the Foreign India 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 Foreign India 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 will be a multi year spillover effect of various taxation regulations.

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.

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.

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 Mastering the Make-in-India Challenge

References & Further Readings

Haritha Saranga, Ram Mudambi, Andreas Schotter (2018), "Mastering the Make-in-India Challenge Harvard Business Review Case Study. Published by HBR Publications.