Engagement to Change Public-Private Policy: Consumer's Choice Limited 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 Engagement to Change Public-Private Policy: Consumer's Choice Limited case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Engagement to Change Public-Private Policy: Consumer's Choice Limited case study is a Harvard Business School (HBR) case study written by Edward Mungai, Ahmad Rahnema. The Engagement to Change Public-Private Policy: Consumer's Choice Limited (referred as “Gel Cooking” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Joint ventures, Marketing, Policy.

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 Engagement to Change Public-Private Policy: Consumer's Choice Limited Case Study

Mohammed Uhuru Kadhi, director of strategy and business development of Consumer's Choice Limited (CCL), was contemplating the changes expected to be caused by the new Excise Duty Act (2015), which was awaiting the assent of Kenya's president. The new act would remove the excise duty on denatured alcohol used in the manufacture of cooking gel. CCL and other stakeholder organizations had been pushing for the duty's abolition for about three years. On that journey, they had learned several lessons that were worthwhile to other institutions and individuals involved in policy and regulatory changes aimed at improving the business environment in east Africa.Given the current high excise duty in Kenya, CCL used to transport denatured alcohol from western Kenya to a factory that manufactured the cooking gel in Moshi, Tanzania, a 600 kilometer journey. The factory subsequently exported most of the cooking gel back to Kenya for sale. The factory also had its own branded cooking stoves, sold in both Tanzania and Kenya. Recently, CCL had designed its own cooking-gel stoves and had them manufactured in China. The stoves could use the cooking gel from several suppliers, including that from the factory in Tanzania.In 2013, CCL and a group of other stakeholder organizations promoting the use of cooking gel and stoves started engaging with the Kenyan government to remove the exercise duty on denatured alcohol. Most of the discussions with the government highlighted the positive environmental benefits of using cooking gel instead of kerosene, wood, charcoal, etc. The removal of excise duty would also be create a business opportunity since it would make it profitable to manufacture the cooking gel in Kenya.Now, in December 2015, with the Excise Duty Bill in its final stages toward approval, Kadhi could not only reflect back on the almost-two-year journey but also contemplate on the future business opportunities. However, all this depended on whether the Kenyan parliament would agree to make the changes to the bill that had been requested by President Uhuru Kenyatta.

Case Authors : Edward Mungai, Ahmad Rahnema

Topic : Innovation & Entrepreneurship

Related Areas : Joint ventures, Marketing, Policy

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Calculating Net Present Value (NPV) at 6% for Engagement to Change Public-Private Policy: Consumer's Choice Limited Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018614)	-10018614	-	-
Year 1	3450228	-6568386	3450228	0.9434	3254932
Year 2	3978529	-2589857	7428757	0.89	3540877
Year 3	3939300	1349443	11368057	0.8396	3307512
Year 4	3234650	4584093	14602707	0.7921	2562146
TOTAL			14602707		12665467

The Net Present Value at 6% discount rate is 2646853

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. 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. Gel Cooking 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 Gel Cooking 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 Engagement to Change Public-Private Policy: Consumer's Choice Limited

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 Innovation & Entrepreneurship 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 Gel Cooking 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 Gel Cooking 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	(10018614)	-10018614	-	-
Year 1	3450228	-6568386	3450228	0.8696	3000198
Year 2	3978529	-2589857	7428757	0.7561	3008340
Year 3	3939300	1349443	11368057	0.6575	2590154
Year 4	3234650	4584093	14602707	0.5718	1849422
TOTAL					10448113

The Net NPV after 4 years is 429499

(10448113 - 10018614 )

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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	(10018614)	-10018614	-	-
Year 1	3450228	-6568386	3450228	0.8333	2875190
Year 2	3978529	-2589857	7428757	0.6944	2762867
Year 3	3939300	1349443	11368057	0.5787	2279688
Year 4	3234650	4584093	14602707	0.4823	1559920
TOTAL					9477665

The Net NPV after 4 years is -540949

At 20% discount rate the NPV is negative (9477665 - 10018614 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Gel Cooking 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 Gel Cooking has a NPV value higher than Zero then finance managers at Gel Cooking 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 Gel Cooking, then the stock price of the Gel Cooking 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 Gel Cooking 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 will be a multi year spillover effect of various taxation regulations.

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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What can impact the cash flow of the project.

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.

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Negotiation Strategy of Engagement to Change Public-Private Policy: Consumer's Choice Limited

References & Further Readings

Edward Mungai, Ahmad Rahnema (2018), "Engagement to Change Public-Private Policy: Consumer's Choice Limited Harvard Business Review Case Study. Published by HBR Publications.