Scale without Growth: INFONAVIT's Expansion in the Mexican Mortgage Market 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 Scale without Growth: INFONAVIT's Expansion in the Mexican Mortgage Market case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Scale without Growth: INFONAVIT's Expansion in the Mexican Mortgage Market case study is a Harvard Business School (HBR) case study written by Paulina Campos, Marco Lopez, Guy Stuart. The Scale without Growth: INFONAVIT's Expansion in the Mexican Mortgage Market (referred as “Infonavit Percent” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Economics, Financial management, Innovation, Social enterprise, Strategic planning.

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 Scale without Growth: INFONAVIT's Expansion in the Mexican Mortgage Market Case Study

According to a World Bank report written in 2001, "in a modern, globally integrated Mexican economy, it is hard to argue for the continued existence of an institution such as INFONAVIT." The report went on to argue that the first-best option was "closing INFONAVIT." In the same year Victor Borras and a new team of managers took control of INFONAVIT under the new PAN government of Vicente Fox. In 2005 the fund issued 376,444 mortgage loans, one and a half times the number issued by INFONAVIT in 2000. During this same period of expansion INFONAVIT had: reduced its defaulted loan rate from 21.7 percent in 2000 to 6.6 percent in 2005; increased its productivity from 51 loans granted per employee to 98 per employee through outsourcing and the modernization and streamlining of operations; launched a new vivienda economica (affordable housing) program to target the majority of its members who earned less than four times the minimum wage (TMW); helped jump-start a nascent housing development industry; increased the real return to the pensioners' funds from 2 percent to 3.5 percent per year; and issued approximately $4.5 billion in mortgage-backed bonds. The case can be used to teach about government innovation, privatization, strategic management, and the public provision of financial services. It would also be appropriate for a course in international development or international housing. It raises questions about the appropriate role of government in the provision of financial services, as well as the role outsourcing and privatization can play in promoting the efficiency and effectiveness of public services, especially when the government is a major purchaser in a market of relatively small suppliers. HKS Case Number 1878.0`

Case Authors : Paulina Campos, Marco Lopez, Guy Stuart

Topic : Finance & Accounting

Related Areas : Economics, Financial management, Innovation, Social enterprise, Strategic planning

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Calculating Net Present Value (NPV) at 6% for Scale without Growth: INFONAVIT's Expansion in the Mexican Mortgage Market Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10026243)	-10026243	-	-
Year 1	3470685	-6555558	3470685	0.9434	3274231
Year 2	3953892	-2601666	7424577	0.89	3518950
Year 3	3941555	1339889	11366132	0.8396	3309406
Year 4	3242090	4581979	14608222	0.7921	2568039
TOTAL			14608222		12670625

The Net Present Value at 6% discount rate is 2644382

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

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. Infonavit Percent 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 Infonavit Percent 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 Scale without Growth: INFONAVIT's Expansion in the Mexican Mortgage Market

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 Infonavit Percent 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 Infonavit Percent 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	(10026243)	-10026243	-	-
Year 1	3470685	-6555558	3470685	0.8696	3017987
Year 2	3953892	-2601666	7424577	0.7561	2989710
Year 3	3941555	1339889	11366132	0.6575	2591636
Year 4	3242090	4581979	14608222	0.5718	1853675
TOTAL					10453009

The Net NPV after 4 years is 426766

(10453009 - 10026243 )

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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	(10026243)	-10026243	-	-
Year 1	3470685	-6555558	3470685	0.8333	2892238
Year 2	3953892	-2601666	7424577	0.6944	2745758
Year 3	3941555	1339889	11366132	0.5787	2280992
Year 4	3242090	4581979	14608222	0.4823	1563508
TOTAL					9482496

The Net NPV after 4 years is -543747

At 20% discount rate the NPV is negative (9482496 - 10026243 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Infonavit Percent 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 Infonavit Percent has a NPV value higher than Zero then finance managers at Infonavit Percent 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 Infonavit Percent, then the stock price of the Infonavit Percent 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 Infonavit Percent 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 can impact the cash flow of 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.

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.

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 Scale without Growth: INFONAVIT's Expansion in the Mexican Mortgage Market

References & Further Readings

Paulina Campos, Marco Lopez, Guy Stuart (2018), "Scale without Growth: INFONAVIT's Expansion in the Mexican Mortgage Market Harvard Business Review Case Study. Published by HBR Publications.