×




Kaiser Steel Corp.--1984 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 Kaiser Steel Corp.--1984 case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Kaiser Steel Corp.--1984 case study is a Harvard Business School (HBR) case study written by Timothy A. Luehrman. The Kaiser Steel Corp.--1984 (referred as “1984 Kaiser” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Ethics, Growth strategy, Mergers & acquisitions, Regulation, Reorganization.

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 Kaiser Steel Corp.--1984 Case Study


In 1984, Kaiser's shareholders were asked to approve a complicated leveraged buyout of the company. Students are asked to analyze the proposed transaction and make a recommendation. To do this, they must determine who gets what in the deal, whether and how any value is created, whether the post-buyout firm is solvent and adequately capitalized, and how much the newly issued preferred stock is worth. Examines the bankruptcy of the company and the allegations of fraud that followed the 1984 LBO. May be used with Kaiser Steel Corp.--1987.


Case Authors : Timothy A. Luehrman

Topic : Finance & Accounting

Related Areas : Ethics, Growth strategy, Mergers & acquisitions, Regulation, Reorganization




Calculating Net Present Value (NPV) at 6% for Kaiser Steel Corp.--1984 Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10015594) -10015594 - -
Year 1 3471912 -6543682 3471912 0.9434 3275389
Year 2 3968544 -2575138 7440456 0.89 3531990
Year 3 3970280 1395142 11410736 0.8396 3333524
Year 4 3243293 4638435 14654029 0.7921 2568992
TOTAL 14654029 12709894




The Net Present Value at 6% discount rate is 2694300

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. Profitability Index
2. Net Present Value
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. 1984 Kaiser 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 1984 Kaiser 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 Kaiser Steel Corp.--1984

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 Finance & Accounting 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 1984 Kaiser 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 1984 Kaiser 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 (10015594) -10015594 - -
Year 1 3471912 -6543682 3471912 0.8696 3019054
Year 2 3968544 -2575138 7440456 0.7561 3000789
Year 3 3970280 1395142 11410736 0.6575 2610524
Year 4 3243293 4638435 14654029 0.5718 1854363
TOTAL 10484730


The Net NPV after 4 years is 469136

(10484730 - 10015594 )








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 (10015594) -10015594 - -
Year 1 3471912 -6543682 3471912 0.8333 2893260
Year 2 3968544 -2575138 7440456 0.6944 2755933
Year 3 3970280 1395142 11410736 0.5787 2297616
Year 4 3243293 4638435 14654029 0.4823 1564088
TOTAL 9510897


The Net NPV after 4 years is -504697

At 20% discount rate the NPV is negative (9510897 - 10015594 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of 1984 Kaiser 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 1984 Kaiser has a NPV value higher than Zero then finance managers at 1984 Kaiser 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 1984 Kaiser, then the stock price of the 1984 Kaiser 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 1984 Kaiser 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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

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.

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 Kaiser Steel Corp.--1984

References & Further Readings

Timothy A. Luehrman (2018), "Kaiser Steel Corp.--1984 Harvard Business Review Case Study. Published by HBR Publications.


Container Store SWOT Analysis / TOWS Matrix

Services , Retail (Department & Discount)


AXA SWOT Analysis / TOWS Matrix

Financial , Insurance (Life)


China Everbright Intl SWOT Analysis / TOWS Matrix

Capital Goods , Construction Services


City Natural SWOT Analysis / TOWS Matrix

Financial , Misc. Financial Services


LG Electronics SWOT Analysis / TOWS Matrix

Consumer Cyclical , Audio & Video Equipment


BRF SA ON SWOT Analysis / TOWS Matrix

Consumer/Non-Cyclical , Food Processing


MyDx Inc SWOT Analysis / TOWS Matrix

Technology , Scientific & Technical Instr.


Telephone&Data Systems SWOT Analysis / TOWS Matrix

Services , Communications Services


Livzon Pharma SWOT Analysis / TOWS Matrix

Healthcare , Biotechnology & Drugs