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Creating and Sustaining a Social Enterprise: The Vittala Story 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 Creating and Sustaining a Social Enterprise: The Vittala Story case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Creating and Sustaining a Social Enterprise: The Vittala Story case study is a Harvard Business School (HBR) case study written by S. Ramnarayan, Sunita Mehta. The Creating and Sustaining a Social Enterprise: The Vittala Story (referred as “Vittala Eye” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Leadership, Organizational culture, Social enterprise, Social responsibility.

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 Creating and Sustaining a Social Enterprise: The Vittala Story Case Study


Vittala International Institute of Ophthalmology (Vittala), a not-for-profit orgnization was involved in providing free/highly subsidized eye care to the rural and the economically underprivileged population in the state of Karnataka, India. The case describes the challenges faced by the founder and his family in building the state-of-the-art institution and sustaining it through its difficult initial years. They had to build awareness of avoidable blindness, make eye care accessible and affordable, and develop the right networks and alliances, all within limited resources. Unlike certain eye care issues such as cataract, Vittala focused on retinal eye care problems that required periodic monitoring and treatment. Diagnosis required sophisticated and expensive equipment, which had to be made available in far-flung small towns and villages, and that posed difficulties. To address the challenges, the organization and its founders executed pioneering innovations in organizational arrangements and processes. The case closes with the dilemma facing Krishna, Director of Vittala, which was to examine how the social enterprise could enhance the revenue streams to increase Vittala's reach in providing eye to the economically disadvantaged citizens. He needs to consider issues like creating the right balance of paying and non-paying patients to ensure sustainable operations, consistent quality of care, keeping technology updated, and attracting and retaining medical staff with right skills and values. The case is significant as it highlights what is required to make healthcare accessible and affordable to the poor, and how policy measures can be executed at the ground level through appropriate organizing efforts. It describes how the founder inculcated a system of values to keep the family members together, thus contributing to the effectiveness and sustainability of the social enterprise.


Case Authors : S. Ramnarayan, Sunita Mehta

Topic : Innovation & Entrepreneurship

Related Areas : Leadership, Organizational culture, Social enterprise, Social responsibility




Calculating Net Present Value (NPV) at 6% for Creating and Sustaining a Social Enterprise: The Vittala Story Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10017988) -10017988 - -
Year 1 3459808 -6558180 3459808 0.9434 3263970
Year 2 3971188 -2586992 7430996 0.89 3534343
Year 3 3944149 1357157 11375145 0.8396 3311584
Year 4 3251094 4608251 14626239 0.7921 2575171
TOTAL 14626239 12685068




The Net Present Value at 6% discount rate is 2667080

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. Profitability Index
3. Net Present Value
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. Timing of the expected cash flows – stockholders of Vittala Eye 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. Vittala Eye 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 Creating and Sustaining a Social Enterprise: The Vittala Story

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 Innovation & Entrepreneurship 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 Vittala Eye 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 Vittala Eye 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 (10017988) -10017988 - -
Year 1 3459808 -6558180 3459808 0.8696 3008529
Year 2 3971188 -2586992 7430996 0.7561 3002789
Year 3 3944149 1357157 11375145 0.6575 2593342
Year 4 3251094 4608251 14626239 0.5718 1858824
TOTAL 10463483


The Net NPV after 4 years is 445495

(10463483 - 10017988 )








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 (10017988) -10017988 - -
Year 1 3459808 -6558180 3459808 0.8333 2883173
Year 2 3971188 -2586992 7430996 0.6944 2757769
Year 3 3944149 1357157 11375145 0.5787 2282494
Year 4 3251094 4608251 14626239 0.4823 1567850
TOTAL 9491287


The Net NPV after 4 years is -526701

At 20% discount rate the NPV is negative (9491287 - 10017988 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Vittala Eye 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 Vittala Eye has a NPV value higher than Zero then finance managers at Vittala Eye 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 Vittala Eye, then the stock price of the Vittala Eye 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 Vittala Eye 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.

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.

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 Creating and Sustaining a Social Enterprise: The Vittala Story

References & Further Readings

S. Ramnarayan, Sunita Mehta (2018), "Creating and Sustaining a Social Enterprise: The Vittala Story Harvard Business Review Case Study. Published by HBR Publications.


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