The Sinking of Swiber: 'Cause No Harm'? 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 The Sinking of Swiber: 'Cause No Harm'? case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Sinking of Swiber: 'Cause No Harm'? case study is a Harvard Business School (HBR) case study written by Kim Wai Ho, Shirley Koh, Yin Kheng Lau. The The Sinking of Swiber: 'Cause No Harm'? (referred as “Swiber Swiber's” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Financial analysis, Financial management, Strategy.

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 The Sinking of Swiber: 'Cause No Harm'? Case Study

On 27 July 2016, Swiber Holdings Limited, a Singapore Exchange-listed provider of offshore engineering, procurement, installation and construction services for oil and gas companies, filed for voluntary liquidation. Two days later, Swiber withdrew the liquidation application and filed for judicial management instead. Swiber's actions shocked its stakeholders and the market. Its total notes payable was about US$437 million as of 27 July 2016; its debts owed to suppliers and subcontractors were about US$264 million as of 31 May 2016. In contrast, Swiber's market capitalization had shrunk to about US$37 million at the close of 27 July 2016. This case chronicles the rise and fall of Swiber's fortunes, describes the company's financing strategy through the years, and discusses the warning signs that heralded the company's collapse during the prolonged downturn in the oil and gas industry.

Case Authors : Kim Wai Ho, Shirley Koh, Yin Kheng Lau

Topic : Finance & Accounting

Related Areas : Financial analysis, Financial management, Strategy

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Calculating Net Present Value (NPV) at 6% for The Sinking of Swiber: 'Cause No Harm'? Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10010278)	-10010278	-	-
Year 1	3461117	-6549161	3461117	0.9434	3265205
Year 2	3963204	-2585957	7424321	0.89	3527237
Year 3	3952204	1366247	11376525	0.8396	3318347
Year 4	3251045	4617292	14627570	0.7921	2575132
TOTAL			14627570		12685921

The Net Present Value at 6% discount rate is 2675643

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. Net Present Value
3. Internal Rate of Return
4. Profitability Index

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. Swiber Swiber's 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 Swiber Swiber's 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 The Sinking of Swiber: 'Cause No Harm'?

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 Finance & Accounting 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 Swiber Swiber's 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 Swiber Swiber's 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	(10010278)	-10010278	-	-
Year 1	3461117	-6549161	3461117	0.8696	3009667
Year 2	3963204	-2585957	7424321	0.7561	2996752
Year 3	3952204	1366247	11376525	0.6575	2598638
Year 4	3251045	4617292	14627570	0.5718	1858796
TOTAL					10463852

The Net NPV after 4 years is 453574

(10463852 - 10010278 )

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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	(10010278)	-10010278	-	-
Year 1	3461117	-6549161	3461117	0.8333	2884264
Year 2	3963204	-2585957	7424321	0.6944	2752225
Year 3	3952204	1366247	11376525	0.5787	2287155
Year 4	3251045	4617292	14627570	0.4823	1567826
TOTAL					9491471

The Net NPV after 4 years is -518807

At 20% discount rate the NPV is negative (9491471 - 10010278 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Swiber Swiber's 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 Swiber Swiber's has a NPV value higher than Zero then finance managers at Swiber Swiber's 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 Swiber Swiber's, then the stock price of the Swiber Swiber's 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 Swiber Swiber's 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 –

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.

What can impact the cash flow of 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 The Sinking of Swiber: 'Cause No Harm'?

References & Further Readings

Kim Wai Ho, Shirley Koh, Yin Kheng Lau (2018), "The Sinking of Swiber: 'Cause No Harm'? Harvard Business Review Case Study. Published by HBR Publications.