×




Globalization Past, 1850-1914 (A) 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 Globalization Past, 1850-1914 (A) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Globalization Past, 1850-1914 (A) case study is a Harvard Business School (HBR) case study written by Sophus A Reinert, Federica Gabrieli. The Globalization Past, 1850-1914 (A) (referred as “1914 War” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Economics, Economy, Globalization, 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




Case Description of Globalization Past, 1850-1914 (A) Case Study


On the evening of 3 August 1914, British Foreign Secretary Lord Edward Grey contemplated whether to advice King and Parliament to declare war on Germany in the wake of the country's invasion of Belgium, or to stay out of what quickly was becoming a world war triggered by a royal assassination in Sarajevo. Over the past century, the said world had become woven together in ways never before seen, and a truly global economy had emerged that many believed forever would banished the possibility of war altogether. But could trade really assure perpetual peace, and what ultimately mattered most; interest, or principles? The case considers the lessons to be had from the rise and fall of the last great period of globalization.


Case Authors : Sophus A Reinert, Federica Gabrieli

Topic : Global Business

Related Areas : Economics, Economy, Globalization, Organizational culture




Calculating Net Present Value (NPV) at 6% for Globalization Past, 1850-1914 (A) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10027239) -10027239 - -
Year 1 3449827 -6577412 3449827 0.9434 3254554
Year 2 3982707 -2594705 7432534 0.89 3544595
Year 3 3949205 1354500 11381739 0.8396 3315829
Year 4 3223914 4578414 14605653 0.7921 2553642
TOTAL 14605653 12668619


The Net Present Value at 6% discount rate is 2641380

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. Internal Rate of Return
2. Net Present Value
3. Profitability Index
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. 1914 War 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 1914 War 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 Globalization Past, 1850-1914 (A)

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 1914 War 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 1914 War 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 (10027239) -10027239 - -
Year 1 3449827 -6577412 3449827 0.8696 2999850
Year 2 3982707 -2594705 7432534 0.7561 3011499
Year 3 3949205 1354500 11381739 0.6575 2596666
Year 4 3223914 4578414 14605653 0.5718 1843283
TOTAL 10451298


The Net NPV after 4 years is 424059

(10451298 - 10027239 )






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 (10027239) -10027239 - -
Year 1 3449827 -6577412 3449827 0.8333 2874856
Year 2 3982707 -2594705 7432534 0.6944 2765769
Year 3 3949205 1354500 11381739 0.5787 2285420
Year 4 3223914 4578414 14605653 0.4823 1554742
TOTAL 9480787


The Net NPV after 4 years is -546452

At 20% discount rate the NPV is negative (9480787 - 10027239 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of 1914 War 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 1914 War has a NPV value higher than Zero then finance managers at 1914 War 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 1914 War, then the stock price of the 1914 War 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 1914 War 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.

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.

Understanding of risks involved in the project.

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

Sophus A Reinert, Federica Gabrieli (2018), "Globalization Past, 1850-1914 (A) Harvard Business Review Case Study. Published by HBR Publications.