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Rajesh Exports: Gold Trader to International Jewellery Retailer 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 Rajesh Exports: Gold Trader to International Jewellery Retailer case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Rajesh Exports: Gold Trader to International Jewellery Retailer case study is a Harvard Business School (HBR) case study written by Arpita Agnihotri, Saurabh Bhattacharya. The Rajesh Exports: Gold Trader to International Jewellery Retailer (referred as “Rel Jewellery” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, International business, Mergers & acquisitions.

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 Rajesh Exports: Gold Trader to International Jewellery Retailer Case Study


Rajesh Exports Limited (REL), founded by Rajesh Mehta in the 1980s and based in India, was the world's largest, lowest cost gold jewellery manufacturer. REL derived more than 90 per cent of its total revenue from exporting gold jewellery to more than 60 countries; but, in 2017, REL set a goal of increasing the portion of revenue contributed by the retail segment to 90 per cent by 2030-an increase from the current contribution of 10 per cent. REL had initiated strategies to differentiate itself in the retail jewellery segment; nonetheless, analysts were skeptical about REL's ability to achieve its revenue goal. They pointed to the hindrances of severe competition in the global retail jewellery market; REL's lack of experience in retail jewellery; and the perception of low quality associated with products produced in India. Was Mehta's vision to establish REL's presence in the retail segment appropriate, and if so, how could REL overcome the barriers and establish its identity in the international retail jewellery market? Arpita Agnihotri is affiliated with Pennsylvania State University - Harrisburg. Saurabh Bhattacharya is affiliated with Newcastle University.


Case Authors : Arpita Agnihotri, Saurabh Bhattacharya

Topic : Global Business

Related Areas : International business, Mergers & acquisitions




Calculating Net Present Value (NPV) at 6% for Rajesh Exports: Gold Trader to International Jewellery Retailer Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10023751) -10023751 - -
Year 1 3466782 -6556969 3466782 0.9434 3270549
Year 2 3977743 -2579226 7444525 0.89 3540177
Year 3 3954756 1375530 11399281 0.8396 3320489
Year 4 3228926 4604456 14628207 0.7921 2557612
TOTAL 14628207 12688827


The Net Present Value at 6% discount rate is 2665076

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. Profitability Index
3. Internal Rate of Return
4. Payback Period

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. Rel Jewellery 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 Rel Jewellery have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.




Formula and Steps to Calculate Net Present Value (NPV) of Rajesh Exports: Gold Trader to International Jewellery Retailer

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 Rel Jewellery 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 Rel Jewellery 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 (10023751) -10023751 - -
Year 1 3466782 -6556969 3466782 0.8696 3014593
Year 2 3977743 -2579226 7444525 0.7561 3007745
Year 3 3954756 1375530 11399281 0.6575 2600316
Year 4 3228926 4604456 14628207 0.5718 1846149
TOTAL 10468803


The Net NPV after 4 years is 445052

(10468803 - 10023751 )






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 (10023751) -10023751 - -
Year 1 3466782 -6556969 3466782 0.8333 2888985
Year 2 3977743 -2579226 7444525 0.6944 2762322
Year 3 3954756 1375530 11399281 0.5787 2288632
Year 4 3228926 4604456 14628207 0.4823 1557160
TOTAL 9497098


The Net NPV after 4 years is -526653

At 20% discount rate the NPV is negative (9497098 - 10023751 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Rel Jewellery 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 Rel Jewellery has a NPV value higher than Zero then finance managers at Rel Jewellery 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 Rel Jewellery, then the stock price of the Rel Jewellery 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 Rel Jewellery 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 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.

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.




References & Further Readings

Arpita Agnihotri, Saurabh Bhattacharya (2018), "Rajesh Exports: Gold Trader to International Jewellery Retailer Harvard Business Review Case Study. Published by HBR Publications.