Ashar Group: Brokers and Co-opetition in the Life Settlement Industry 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 Ashar Group: Brokers and Co-opetition in the Life Settlement Industry case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Ashar Group: Brokers and Co-opetition in the Life Settlement Industry case study is a Harvard Business School (HBR) case study written by Alexander Braun, Lauren H. Cohen, Christopher Malloy, Jiahua Xu. The Ashar Group: Brokers and Co-opetition in the Life Settlement Industry (referred as “Ashar Policyholders” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Financial management.

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 Ashar Group: Brokers and Co-opetition in the Life Settlement Industry Case Study

Connecting life insurance policyholders with potential investors (called Life Settlement Providers), Ashar Group plays a pivotal role in the industry. Its current position is however increasingly being challenged by consumer-direct models, led by major providers seeking to shortcut brokers. Ashar faces a strategic dilemma in cooperating --- but also competing --- with these providers. Maintaining a mutually beneficial dynamic with policyholders, downstream intermediaries and other actors thus constitutes a balancing act. The context of this case is an underdeveloped market whose reputation has suffered from broker misconduct. In light of the market's legacy issues and competing business models, this case study explores strategies Ashar may pursue to secure and enhance its market position. Discussions emerging from this case study have the potential to illuminate directions for market transformation.

Case Authors : Alexander Braun, Lauren H. Cohen, Christopher Malloy, Jiahua Xu

Topic : Finance & Accounting

Related Areas : Financial management

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Calculating Net Present Value (NPV) at 6% for Ashar Group: Brokers and Co-opetition in the Life Settlement Industry Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10001474)	-10001474	-	-
Year 1	3447436	-6554038	3447436	0.9434	3252298
Year 2	3973094	-2580944	7420530	0.89	3536040
Year 3	3959982	1379038	11380512	0.8396	3324877
Year 4	3237828	4616866	14618340	0.7921	2564663
TOTAL			14618340		12677878

The Net Present Value at 6% discount rate is 2676404

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. Payback Period
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Ashar Policyholders 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 Ashar Policyholders 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 Ashar Group: Brokers and Co-opetition in the Life Settlement Industry

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 Ashar Policyholders 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 Ashar Policyholders 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	(10001474)	-10001474	-	-
Year 1	3447436	-6554038	3447436	0.8696	2997770
Year 2	3973094	-2580944	7420530	0.7561	3004230
Year 3	3959982	1379038	11380512	0.6575	2603752
Year 4	3237828	4616866	14618340	0.5718	1851239
TOTAL					10456991

The Net NPV after 4 years is 455517

(10456991 - 10001474 )

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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	(10001474)	-10001474	-	-
Year 1	3447436	-6554038	3447436	0.8333	2872863
Year 2	3973094	-2580944	7420530	0.6944	2759093
Year 3	3959982	1379038	11380512	0.5787	2291656
Year 4	3237828	4616866	14618340	0.4823	1561453
TOTAL					9485065

The Net NPV after 4 years is -516409

At 20% discount rate the NPV is negative (9485065 - 10001474 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ashar Policyholders 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 Ashar Policyholders has a NPV value higher than Zero then finance managers at Ashar Policyholders 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 Ashar Policyholders, then the stock price of the Ashar Policyholders 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 Ashar Policyholders 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 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 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 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 Ashar Group: Brokers and Co-opetition in the Life Settlement Industry

References & Further Readings

Alexander Braun, Lauren H. Cohen, Christopher Malloy, Jiahua Xu (2018), "Ashar Group: Brokers and Co-opetition in the Life Settlement Industry Harvard Business Review Case Study. Published by HBR Publications.