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White Gold in Benin: Chinese Investment in Cotton 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 White Gold in Benin: Chinese Investment in Cotton case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. White Gold in Benin: Chinese Investment in Cotton case study is a Harvard Business School (HBR) case study written by Zhangfeng Fei, Xiaokang Zhao, Kejing Zhang, Alex Beamish. The White Gold in Benin: Chinese Investment in Cotton (referred as “Cotton Cbt” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Manufacturing, Supply chain.

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 White Gold in Benin: Chinese Investment in Cotton Case Study


In mid-June 2011, the Chinese president of the China-Benin joint venture Benin Textile Company (Compagnie Beninoise des Textiles, or CBT) was deeply worried about the supply of cotton in Benin. Since 2009, CBT had faced significant challenges in obtaining a reliable cotton supply. In 2010, the company had already placed its cotton orders, but local Beninese cotton producers were unwilling to deliver cotton at the earlier agreed-on price due to the rising market price. CBT was forced to stop production for five months and could not deliver on numerous contracts. The president of CBT was unsure whether to stay in West Africa and if so, how to improve the cotton supply situation. He had four options: maintain the status quo and hope for improvements, withdraw from West Africa, buy cotton contracts from other countries, or invest in cotton production. Which would be the best option for his company? The authors are Zhangfeng Fei, Xiaokang Zhao and Kejing Zhang are affiliated with Donghua University. Alex Beamish is affiliated with Ivey Publishing.


Case Authors : Zhangfeng Fei, Xiaokang Zhao, Kejing Zhang, Alex Beamish

Topic : Global Business

Related Areas : Manufacturing, Supply chain




Calculating Net Present Value (NPV) at 6% for White Gold in Benin: Chinese Investment in Cotton Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10024223) -10024223 - -
Year 1 3472108 -6552115 3472108 0.9434 3275574
Year 2 3959199 -2592916 7431307 0.89 3523673
Year 3 3936898 1343982 11368205 0.8396 3305495
Year 4 3251422 4595404 14619627 0.7921 2575431
TOTAL 14619627 12680173




The Net Present Value at 6% discount rate is 2655950

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. 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 Cotton Cbt 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. Cotton Cbt 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 White Gold in Benin: Chinese Investment in Cotton

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 Global Business 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 Cotton Cbt 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 Cotton Cbt 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 (10024223) -10024223 - -
Year 1 3472108 -6552115 3472108 0.8696 3019224
Year 2 3959199 -2592916 7431307 0.7561 2993723
Year 3 3936898 1343982 11368205 0.6575 2588574
Year 4 3251422 4595404 14619627 0.5718 1859011
TOTAL 10460533


The Net NPV after 4 years is 436310

(10460533 - 10024223 )








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 (10024223) -10024223 - -
Year 1 3472108 -6552115 3472108 0.8333 2893423
Year 2 3959199 -2592916 7431307 0.6944 2749444
Year 3 3936898 1343982 11368205 0.5787 2278297
Year 4 3251422 4595404 14619627 0.4823 1568008
TOTAL 9489173


The Net NPV after 4 years is -535050

At 20% discount rate the NPV is negative (9489173 - 10024223 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Cotton Cbt 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 Cotton Cbt has a NPV value higher than Zero then finance managers at Cotton Cbt 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 Cotton Cbt, then the stock price of the Cotton Cbt 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 Cotton Cbt 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.

Understanding of risks involved in the project.

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.

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 White Gold in Benin: Chinese Investment in Cotton

References & Further Readings

Zhangfeng Fei, Xiaokang Zhao, Kejing Zhang, Alex Beamish (2018), "White Gold in Benin: Chinese Investment in Cotton Harvard Business Review Case Study. Published by HBR Publications.


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