An Inside Perspective on Carbon Disclosure 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 An Inside Perspective on Carbon Disclosure case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. An Inside Perspective on Carbon Disclosure case study is a Harvard Business School (HBR) case study written by Christian Blanco, Felipe Caro, Charles J. Corbett. The An Inside Perspective on Carbon Disclosure (referred as “Disclosure Cdp” 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, Strategic planning, 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 An Inside Perspective on Carbon Disclosure Case Study

Part of the underlying vision of CDP (formerly the Carbon Disclosure Project) is to enhance firms' climate change strategies by encouraging them to measure their emissions and corresponding risks and opportunities. Drawing on interviews with 38 firms in seven countries that participated in CDP, we found that the benefits firms experience from the measurement and disclosure process are more diverse in nature than expected. They can be both operational and strategic, and internal as well as external. From our analysis of the firms' experiences, we draw several implications for managers. First, managers should beware of various biases that may inhibit investments in profitable emission reduction opportunities. Second, participating in a disclosure-oriented process can be beneficial, even for a firm that ultimately decides not to disclose. Third, when disclosing greenhouse gas-related information, managers need to address multiple groups of stakeholders, not just investors. Fourth, when searching for emission reduction opportunities and in organizing the disclosure process, managers should not neglect opportunities that exist elsewhere in the supply chain.

Case Authors : Christian Blanco, Felipe Caro, Charles J. Corbett

Topic : Leadership & Managing People

Related Areas : Strategic planning, Sustainability

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Calculating Net Present Value (NPV) at 6% for An Inside Perspective on Carbon Disclosure Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10026314)	-10026314	-	-
Year 1	3452268	-6574046	3452268	0.9434	3256857
Year 2	3957312	-2616734	7409580	0.89	3521994
Year 3	3967731	1350997	11377311	0.8396	3331383
Year 4	3240215	4591212	14617526	0.7921	2566554
TOTAL			14617526		12676787

The Net Present Value at 6% discount rate is 2650473

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. 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. Timing of the expected cash flows – stockholders of Disclosure Cdp 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. Disclosure Cdp shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of An Inside Perspective on Carbon Disclosure

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 Disclosure Cdp 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 Disclosure Cdp 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	(10026314)	-10026314	-	-
Year 1	3452268	-6574046	3452268	0.8696	3001972
Year 2	3957312	-2616734	7409580	0.7561	2992296
Year 3	3967731	1350997	11377311	0.6575	2608848
Year 4	3240215	4591212	14617526	0.5718	1852603
TOTAL					10455720

The Net NPV after 4 years is 429406

(10455720 - 10026314 )

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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	(10026314)	-10026314	-	-
Year 1	3452268	-6574046	3452268	0.8333	2876890
Year 2	3957312	-2616734	7409580	0.6944	2748133
Year 3	3967731	1350997	11377311	0.5787	2296141
Year 4	3240215	4591212	14617526	0.4823	1562604
TOTAL					9483768

The Net NPV after 4 years is -542546

At 20% discount rate the NPV is negative (9483768 - 10026314 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Disclosure Cdp 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 Disclosure Cdp has a NPV value higher than Zero then finance managers at Disclosure Cdp 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 Disclosure Cdp, then the stock price of the Disclosure Cdp 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 Disclosure Cdp 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.

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 can impact the cash flow of the project.

What will be a multi year spillover effect of various taxation regulations.

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 An Inside Perspective on Carbon Disclosure

References & Further Readings

Christian Blanco, Felipe Caro, Charles J. Corbett (2018), "An Inside Perspective on Carbon Disclosure Harvard Business Review Case Study. Published by HBR Publications.