Maruti Suzuki India Limited: Leveraging the Changed Economy 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 Maruti Suzuki India Limited: Leveraging the Changed Economy case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Maruti Suzuki India Limited: Leveraging the Changed Economy case study is a Harvard Business School (HBR) case study written by Prateeksha Parihar, Jagrook Dawra, Vinita Sahay. The Maruti Suzuki India Limited: Leveraging the Changed Economy (referred as “Car Msil's” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Marketing.

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 Maruti Suzuki India Limited: Leveraging the Changed Economy Case Study

Although Maruti Suzuki India Limited (MSIL) was the leader in passenger vehicle sales in India in May 2015, it was having difficulties breaking into the high-end car segment. There were multiple strategies that MSIL could have used to deal with this problem, such as; changing its brand image from small automaker to high-end automaker; staying in the small car market; penetrating the market further by introducing new models and their variants in the same segment; or striking a balance between both of the other suggestions (i.e., a mixed strategy). A sudden change in MSIL's image could harm the company's existing share of the small car segment. At the same time, remaining firmly in the small car market could be detrimental for MSIL's market leader position in the years following, as the small-car-dominated market was gradually moving towards segments such as mid-size and executive cars in India. Which strategy (or combination of strategies) should the company pursue? The authors Prateeksha Parihar, Jagrook Dawra, and Vinita Sahay are affiliated with Indian Institute of Management Raipur.

Case Authors : Prateeksha Parihar, Jagrook Dawra, Vinita Sahay

Topic : Sales & Marketing

Related Areas : Marketing

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Calculating Net Present Value (NPV) at 6% for Maruti Suzuki India Limited: Leveraging the Changed Economy Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10003880)	-10003880	-	-
Year 1	3449891	-6553989	3449891	0.9434	3254614
Year 2	3973535	-2580454	7423426	0.89	3536432
Year 3	3955878	1375424	11379304	0.8396	3321431
Year 4	3235530	4610954	14614834	0.7921	2562843
TOTAL			14614834		12675320

The Net Present Value at 6% discount rate is 2671440

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. 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. Timing of the expected cash flows – stockholders of Car Msil's 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. Car Msil's 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 Maruti Suzuki India Limited: Leveraging the Changed Economy

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 Sales & Marketing 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 Car Msil's 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 Car Msil's 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	(10003880)	-10003880	-	-
Year 1	3449891	-6553989	3449891	0.8696	2999905
Year 2	3973535	-2580454	7423426	0.7561	3004563
Year 3	3955878	1375424	11379304	0.6575	2601054
Year 4	3235530	4610954	14614834	0.5718	1849925
TOTAL					10455447

The Net NPV after 4 years is 451567

(10455447 - 10003880 )

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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	(10003880)	-10003880	-	-
Year 1	3449891	-6553989	3449891	0.8333	2874909
Year 2	3973535	-2580454	7423426	0.6944	2759399
Year 3	3955878	1375424	11379304	0.5787	2289281
Year 4	3235530	4610954	14614834	0.4823	1560344
TOTAL					9483934

The Net NPV after 4 years is -519946

At 20% discount rate the NPV is negative (9483934 - 10003880 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Car Msil's 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 Car Msil's has a NPV value higher than Zero then finance managers at Car Msil's 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 Car Msil's, then the stock price of the Car Msil's 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 Car Msil's 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 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.

Understanding of risks involved in the project.

What can impact the cash flow of 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 Maruti Suzuki India Limited: Leveraging the Changed Economy

References & Further Readings

Prateeksha Parihar, Jagrook Dawra, Vinita Sahay (2018), "Maruti Suzuki India Limited: Leveraging the Changed Economy Harvard Business Review Case Study. Published by HBR Publications.