Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. SABMiller South Africa: Contextual Leadership in Transforming Culture case study is a Harvard Business School (HBR) case study written by Caren Scheepers, Amy Moore. The SABMiller South Africa: Contextual Leadership in Transforming Culture (referred as “Bachulal Polokwane” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, .

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.

In March 2017, Ajay Maharaj Bachulal was starting his new position as plant manager at SABMiller plc's (SABMiller's) plant in Polokwane, South Africa. Bachulal had successfully led change at the company's brewery in another province, and he hoped to be as successful at the new plant. His dilemma was how to approach the workforce in Polokwane, and how to adapt to and make changes within the culture specific to that plant. While both plants adhered to SABMiller's system, policies, and procedures, Bachulal sensed that the approach of each plant to work and life was different. How would Bachulal's own leadership development process, and his efforts to change culture by empowering lower level employees in Polokwane, help him in a different province with distinct ethnic compositions, languages, and cultures? Caren Scheepers is affiliated with University of Pretoria.

Years | Cash Flow | Net Cash Flow | Cumulative Cash Flow |
Discount Rate @ 6 % |
Discounted Cash Flows |
---|---|---|---|---|---|

Year 0 | (10015802) | -10015802 | - | - | |

Year 1 | 3452585 | -6563217 | 3452585 | 0.9434 | 3257156 |

Year 2 | 3962791 | -2600426 | 7415376 | 0.89 | 3526870 |

Year 3 | 3936815 | 1336389 | 11352191 | 0.8396 | 3305426 |

Year 4 | 3245142 | 4581531 | 14597333 | 0.7921 | 2570456 |

TOTAL | 14597333 | 12659908 |

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 -

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

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

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

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 Bachulal Polokwane 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 Bachulal Polokwane 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.

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 | (10015802) | -10015802 | - | - | |

Year 1 | 3452585 | -6563217 | 3452585 | 0.8696 | 3002248 |

Year 2 | 3962791 | -2600426 | 7415376 | 0.7561 | 2996439 |

Year 3 | 3936815 | 1336389 | 11352191 | 0.6575 | 2588520 |

Year 4 | 3245142 | 4581531 | 14597333 | 0.5718 | 1855420 |

TOTAL | 10442627 |

(10442627 - 10015802 )

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 | (10015802) | -10015802 | - | - | |

Year 1 | 3452585 | -6563217 | 3452585 | 0.8333 | 2877154 |

Year 2 | 3962791 | -2600426 | 7415376 | 0.6944 | 2751938 |

Year 3 | 3936815 | 1336389 | 11352191 | 0.5787 | 2278249 |

Year 4 | 3245142 | 4581531 | 14597333 | 0.4823 | 1564980 |

TOTAL | 9472322 |

At 20% discount rate the NPV is negative (9472322 - 10015802 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Bachulal Polokwane to discount cash flow at lower discount rates such as 15%.

Simplest Approach – If the investment project of Bachulal Polokwane has a NPV value higher than Zero then finance managers at Bachulal Polokwane 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 Bachulal Polokwane, then the stock price of the Bachulal Polokwane 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.

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Bachulal Polokwane 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 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.

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.

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.

** Caren Scheepers, Amy Moore (2018)**, "SABMiller South Africa: Contextual Leadership in Transforming Culture Harvard Business Review Case Study. Published by HBR Publications.

- Diglot Capital Management: A Very Serious Ghost Story Net Present Value (NPV) Case Study Solution & Analysis
- Leading Open Innovation at BT Net Present Value (NPV) Case Study Solution & Analysis
- Divestment of Changi International Airport Services by Temasek Holdings Net Present Value (NPV) Case Study Solution & Analysis
- Posana Integrative Wellness: A Start-Up Business Net Present Value (NPV)Case Study Solution & Analysis
- Indian Premier League Net Present Value (NPV) Case Study Solution & Analysis

- America's Depression of 1784-1787 and the Advent of Nationalism Net Present Value (NPV) Case Study Solution & Analysis
- Nicholas Kristof and Sheryl WuDunn: The Power of Writing to Launch and Sustain a Movement Net Present Value (NPV) Case Study Solution & Analysis
- Antara: Building Experiences in Senior Living Net Present Value (NPV) Case Study Solution & Analysis
- TraumaLink: Providing Trauma First Aid Services in Bangladesh Using Trained Volunteers Net Present Value (NPV) Case Study Solution & Analysis
- Acumen: Managing Towards Impact 2018 Net Present Value (NPV) Case Study Solution & Analysis

Feel free to connect with us if you need business research.

You can download Excel Template of Case Study Solution & Analysis of SABMiller South Africa: Contextual Leadership in Transforming Culture