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IMPSA: Restructuring to Innovate with Existing Resources 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 IMPSA: Restructuring to Innovate with Existing Resources case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. IMPSA: Restructuring to Innovate with Existing Resources case study is a Harvard Business School (HBR) case study written by Daniel Friel. The IMPSA: Restructuring to Innovate with Existing Resources (referred as “Impsa Executive” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Mergers & acquisitions, Reorganization.

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 IMPSA: Restructuring to Innovate with Existing Resources Case Study


In late 2012, an executive vice-president faced a dilemma at Industrias Metalurgicas Pescarmona S.A. (IMPSA), an Argentine multinational company that designed and produced cranes, dams, and components for power plants, and had recently begun building hydroelectric and wind power projects. The company's chief executive officer had tasked the executive vice-president with recommending how IMPSA could be radically restructured to adapt to changes in the world marketplace for renewable energy. However, IMPSA was at the top of its game, and the company had a backlog of orders valued at US$3.3 billion. The executive vice-president knew that the chief executive officer would not accept a minor reorganization but would demand a major restructuring based on the firm's existing resources, which was a strategy that, in the past, had proven to be successful for the company, particularly in emerging markets. The executive vice-president wondered how IMPSA could build on its existing wind power and hydroelectric dam business without abandoning the resources the firm had developed over the years. Daniel Friel is affiliated with Universidad de San Andres.


Case Authors : Daniel Friel

Topic : Global Business

Related Areas : Mergers & acquisitions, Reorganization




Calculating Net Present Value (NPV) at 6% for IMPSA: Restructuring to Innovate with Existing Resources Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10013457) -10013457 - -
Year 1 3470229 -6543228 3470229 0.9434 3273801
Year 2 3981620 -2561608 7451849 0.89 3543628
Year 3 3937547 1375939 11389396 0.8396 3306040
Year 4 3233480 4609419 14622876 0.7921 2561219
TOTAL 14622876 12684688




The Net Present Value at 6% discount rate is 2671231

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. Internal Rate of Return
2. Payback Period
3. Net Present Value
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. Timing of the expected cash flows – stockholders of Impsa Executive 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. Impsa Executive shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of IMPSA: Restructuring to Innovate with Existing Resources

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 Impsa Executive 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 Impsa Executive 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 (10013457) -10013457 - -
Year 1 3470229 -6543228 3470229 0.8696 3017590
Year 2 3981620 -2561608 7451849 0.7561 3010677
Year 3 3937547 1375939 11389396 0.6575 2589001
Year 4 3233480 4609419 14622876 0.5718 1848753
TOTAL 10466021


The Net NPV after 4 years is 452564

(10466021 - 10013457 )








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 (10013457) -10013457 - -
Year 1 3470229 -6543228 3470229 0.8333 2891858
Year 2 3981620 -2561608 7451849 0.6944 2765014
Year 3 3937547 1375939 11389396 0.5787 2278673
Year 4 3233480 4609419 14622876 0.4823 1559356
TOTAL 9494900


The Net NPV after 4 years is -518557

At 20% discount rate the NPV is negative (9494900 - 10013457 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Impsa Executive 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 Impsa Executive has a NPV value higher than Zero then finance managers at Impsa Executive 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 Impsa Executive, then the stock price of the Impsa Executive 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 Impsa Executive 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 can impact the cash flow of the project.

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

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.

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 IMPSA: Restructuring to Innovate with Existing Resources

References & Further Readings

Daniel Friel (2018), "IMPSA: Restructuring to Innovate with Existing Resources Harvard Business Review Case Study. Published by HBR Publications.


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