Parliamentary Election Impact on Indian Capital Markets 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 Parliamentary Election Impact on Indian Capital Markets case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Parliamentary Election Impact on Indian Capital Markets case study is a Harvard Business School (HBR) case study written by Vipul Kumar Singh, Faisal Ahmed. The Parliamentary Election Impact on Indian Capital Markets (referred as “Analyst Elections” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Strategy.

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 Parliamentary Election Impact on Indian Capital Markets Case Study

On the eve of the announcement of the results of India's 2009 elections, a senior research analyst with a leading brokerage and investment house in India was trying to predict the possible outcomes of the election and to gauge their impact on the stock markets. The analyst wanted to recommend some optimal options strategies to his clients, as the outcome of events such as elections always led to high volatility and consequently high risks and returns. The formation of a majority government would likely give a significant boost to the markets, while the formation of a coalition government would likely have the opposite effect. The analyst was struggling to determine the kind of strategy (aggressive or defensive) he should suggest. He was working to help his clients make exponential profits in a short span of time without the fear of losing significant money.

Case Authors : Vipul Kumar Singh, Faisal Ahmed

Topic : Finance & Accounting

Related Areas : Strategy

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Calculating Net Present Value (NPV) at 6% for Parliamentary Election Impact on Indian Capital Markets Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10014617)	-10014617	-	-
Year 1	3471107	-6543510	3471107	0.9434	3274629
Year 2	3966272	-2577238	7437379	0.89	3529968
Year 3	3973188	1395950	11410567	0.8396	3335965
Year 4	3222946	4618896	14633513	0.7921	2552875
TOTAL			14633513		12693438

The Net Present Value at 6% discount rate is 2678821

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. Payback Period
2. Net Present Value
3. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Analyst Elections 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 Analyst Elections 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 Parliamentary Election Impact on Indian Capital Markets

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 Analyst Elections 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 Analyst Elections 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	(10014617)	-10014617	-	-
Year 1	3471107	-6543510	3471107	0.8696	3018354
Year 2	3966272	-2577238	7437379	0.7561	2999071
Year 3	3973188	1395950	11410567	0.6575	2612436
Year 4	3222946	4618896	14633513	0.5718	1842730
TOTAL					10472591

The Net NPV after 4 years is 457974

(10472591 - 10014617 )

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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	(10014617)	-10014617	-	-
Year 1	3471107	-6543510	3471107	0.8333	2892589
Year 2	3966272	-2577238	7437379	0.6944	2754356
Year 3	3973188	1395950	11410567	0.5787	2299299
Year 4	3222946	4618896	14633513	0.4823	1554276
TOTAL					9500519

The Net NPV after 4 years is -514098

At 20% discount rate the NPV is negative (9500519 - 10014617 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Analyst Elections 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 Analyst Elections has a NPV value higher than Zero then finance managers at Analyst Elections 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 Analyst Elections, then the stock price of the Analyst Elections 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 Analyst Elections 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 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.

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.

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 Parliamentary Election Impact on Indian Capital Markets

References & Further Readings

Vipul Kumar Singh, Faisal Ahmed (2018), "Parliamentary Election Impact on Indian Capital Markets Harvard Business Review Case Study. Published by HBR Publications.