Turnaround of Food and Civil Supplies Department in Telangana Government 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 Turnaround of Food and Civil Supplies Department in Telangana Government case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Turnaround of Food and Civil Supplies Department in Telangana Government case study is a Harvard Business School (HBR) case study written by S. Ramnarayan, Sunita Mehta. The Turnaround of Food and Civil Supplies Department in Telangana Government (referred as “Anand Telangana” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Communication, Conflict, Crisis management, Influence, Leadership, Organizational culture.

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 Turnaround of Food and Civil Supplies Department in Telangana Government Case Study

CV Anand, a senior officer of the Indian Police Service (IPS) was assigned to lead the Food and Civil Supplies Department in the state of Telangana, India by the Chief Minister - the top political executive of the state. Since the role involved policy making and implementation relating to procurement and processing of grains, transportation and distribution to the poorer sections of the society, this was a highly unusual role assignment for an IPS officer. The organization had the responsibility of procuring food grains from farmers at minimum support price, and then after rice milling, arranging distribution to lower income population needing rice at subsidized rates. Anand observed a culture of ritualistic decision making, political power plays, and shortage of talent leading to the neglect of key aspects. The funds crisis had arisen due to non-receipt of dues and there were mounting interest charges. Certain parties were exploiting the system and getting away with it. There were archaic procedures, and corruption at different levels. Anand initiated multiple initiatives in the areas of: organizational aspects, technology and systems. He made conscious efforts to mobilize support. With passion, persistence and hard work, different stakeholders were influenced. Time, energy and commitment were allocated to high leverage activities. Within a year of assuming leadership, the result of turnaround was evident - the funds crisis had eased, bulk of leakages had been plugged and the system had become responsive to the needs of its key stakeholders - the farmers and the needy beneficiaries. Anand knew that he was on a short-term deputation and that he would be transferred to another assignment in the following six to eight months. He was concerned about what he should do in the remaining months to ensure that the changes stick and are not leader-dependent for their continuation.

Case Authors : S. Ramnarayan, Sunita Mehta

Topic : Organizational Development

Related Areas : Communication, Conflict, Crisis management, Influence, Leadership, Organizational culture

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Calculating Net Present Value (NPV) at 6% for Turnaround of Food and Civil Supplies Department in Telangana Government Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018088)	-10018088	-	-
Year 1	3462175	-6555913	3462175	0.9434	3266203
Year 2	3981092	-2574821	7443267	0.89	3543158
Year 3	3966101	1391280	11409368	0.8396	3330015
Year 4	3250778	4642058	14660146	0.7921	2574921
TOTAL			14660146		12714296

The Net Present Value at 6% discount rate is 2696208

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. Profitability Index
2. Net Present Value
3. Payback Period
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. Timing of the expected cash flows – stockholders of Anand Telangana 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. Anand Telangana shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Turnaround of Food and Civil Supplies Department in Telangana Government

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 Organizational Development 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 Anand Telangana 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 Anand Telangana 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	(10018088)	-10018088	-	-
Year 1	3462175	-6555913	3462175	0.8696	3010587
Year 2	3981092	-2574821	7443267	0.7561	3010278
Year 3	3966101	1391280	11409368	0.6575	2607776
Year 4	3250778	4642058	14660146	0.5718	1858643
TOTAL					10487283

The Net NPV after 4 years is 469195

(10487283 - 10018088 )

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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	(10018088)	-10018088	-	-
Year 1	3462175	-6555913	3462175	0.8333	2885146
Year 2	3981092	-2574821	7443267	0.6944	2764647
Year 3	3966101	1391280	11409368	0.5787	2295197
Year 4	3250778	4642058	14660146	0.4823	1567698
TOTAL					9512688

The Net NPV after 4 years is -505400

At 20% discount rate the NPV is negative (9512688 - 10018088 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Anand Telangana 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 Anand Telangana has a NPV value higher than Zero then finance managers at Anand Telangana 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 Anand Telangana, then the stock price of the Anand Telangana 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 Anand Telangana 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.

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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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 Turnaround of Food and Civil Supplies Department in Telangana Government

References & Further Readings

S. Ramnarayan, Sunita Mehta (2018), "Turnaround of Food and Civil Supplies Department in Telangana Government Harvard Business Review Case Study. Published by HBR Publications.