India's Passion for Gold: Velvetcase 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 India's Passion for Gold: Velvetcase case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. India's Passion for Gold: Velvetcase case study is a Harvard Business School (HBR) case study written by Nupur Pavan Bang, Puran Singh, Vikram Kuriyan. The India's Passion for Gold: Velvetcase (referred as “Gold Jewellery” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, 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

Case Description of India's Passion for Gold: Velvetcase Case Study

The largest consumer of gold in the world in 2012-2013, India was a growing market for gold jewellery, largely owing to its importance in the cultural and religious traditions of the country. Gold prices in international markets had been increasing, but this had little impact on India's voracious appetite for gold. Heavy gold imports had led to an increase in country's fiscal deficit above the sustainable level of 2.5-3% of gross domestic product (GDP) and touched 4.2% in FY2012. Velvetcase, a made-to-order jewellery company in Mumbai, had started operations in the beginning of 2013 and was concerned by the government's recent policies on gold imports. Among many other measures, the Indian government had raised import duty from 4% to 10% during the year. The increase in import duties raised input prices, consequently slowing the demand for gold jewellery to some extent. Velvetcase believed that its unique business model of making jewellery using low karat gold would not only satisfy India's passion for gold, but also result in improving the current account deficit (CAD) of the country by lowering the amount (in grams) of gold used in the making of jewellery.

Case Authors : Nupur Pavan Bang, Puran Singh, Vikram Kuriyan

Topic : Finance & Accounting

Related Areas : Policy

Calculating Net Present Value (NPV) at 6% for India's Passion for Gold: Velvetcase Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10002035) -10002035 - -
Year 1 3467695 -6534340 3467695 0.9434 3271410
Year 2 3971183 -2563157 7438878 0.89 3534339
Year 3 3971590 1408433 11410468 0.8396 3334624
Year 4 3227444 4635877 14637912 0.7921 2556438
TOTAL 14637912 12696811

The Net Present Value at 6% discount rate is 2694776

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. Internal Rate of Return
3. Net Present Value
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. Gold 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 Gold 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 India's Passion for Gold: Velvetcase

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 Gold 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 Gold 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 %
Cash Flows
Year 0 (10002035) -10002035 - -
Year 1 3467695 -6534340 3467695 0.8696 3015387
Year 2 3971183 -2563157 7438878 0.7561 3002785
Year 3 3971590 1408433 11410468 0.6575 2611385
Year 4 3227444 4635877 14637912 0.5718 1845302
TOTAL 10474858

The Net NPV after 4 years is 472823

(10474858 - 10002035 )

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 %
Cash Flows
Year 0 (10002035) -10002035 - -
Year 1 3467695 -6534340 3467695 0.8333 2889746
Year 2 3971183 -2563157 7438878 0.6944 2757766
Year 3 3971590 1408433 11410468 0.5787 2298374
Year 4 3227444 4635877 14637912 0.4823 1556445
TOTAL 9502330

The Net NPV after 4 years is -499705

At 20% discount rate the NPV is negative (9502330 - 10002035 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Gold 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 Gold Jewellery has a NPV value higher than Zero then finance managers at Gold 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 Gold Jewellery, then the stock price of the Gold 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 Gold 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 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.

Understanding of risks involved in the project.

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.

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

Nupur Pavan Bang, Puran Singh, Vikram Kuriyan (2018), "India's Passion for Gold: Velvetcase Harvard Business Review Case Study. Published by HBR Publications.