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Mobil in Aceh, Indonesia (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 Mobil in Aceh, Indonesia (A) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Mobil in Aceh, Indonesia (A) case study is a Harvard Business School (HBR) case study written by Henri-Claude De Bettignies, Liana Downey. The Mobil in Aceh, Indonesia (A) (referred as “Mobil Aceh” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Government, Public relations, Social responsibility.

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 Mobil in Aceh, Indonesia (A) Case Study


In December 1998, Ron Wilson, chief executive of Mobil Oil Indonesia (MOI), considered how he should respond to allegations made by a group of nongovernmental organizations that Mobil had been complicit in serious human rights abuses in Aceh, Indonesia. MOI, established in 1968, was a joint venture between Mobil and the Indonesian oil company Pertamina. Based in Lhokseumawe, MOI was responsible for setting and managing the terms of the various contracts with Pertamina and the Indonesian government and for establishing and managing the exploration and exploitation operations. As a location, Aceh was far from convenient. But could any of the team at Mobil have imagined just how challenging managing operations in Aceh would be?


Case Authors : Henri-Claude De Bettignies, Liana Downey

Topic : Global Business

Related Areas : Government, Public relations, Social responsibility




Calculating Net Present Value (NPV) at 6% for Mobil in Aceh, Indonesia (A) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10026503) -10026503 - -
Year 1 3446564 -6579939 3446564 0.9434 3251475
Year 2 3971384 -2608555 7417948 0.89 3534518
Year 3 3967822 1359267 11385770 0.8396 3331460
Year 4 3234378 4593645 14620148 0.7921 2561930
TOTAL 14620148 12679383




The Net Present Value at 6% discount rate is 2652880

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. Payback Period
3. Profitability Index
4. Net Present Value

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. Mobil Aceh 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 Mobil Aceh 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 Mobil in Aceh, Indonesia (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 Mobil Aceh 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 Mobil Aceh 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 (10026503) -10026503 - -
Year 1 3446564 -6579939 3446564 0.8696 2997012
Year 2 3971384 -2608555 7417948 0.7561 3002937
Year 3 3967822 1359267 11385770 0.6575 2608907
Year 4 3234378 4593645 14620148 0.5718 1849266
TOTAL 10458123


The Net NPV after 4 years is 431620

(10458123 - 10026503 )








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 (10026503) -10026503 - -
Year 1 3446564 -6579939 3446564 0.8333 2872137
Year 2 3971384 -2608555 7417948 0.6944 2757906
Year 3 3967822 1359267 11385770 0.5787 2296193
Year 4 3234378 4593645 14620148 0.4823 1559789
TOTAL 9486024


The Net NPV after 4 years is -540479

At 20% discount rate the NPV is negative (9486024 - 10026503 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Mobil Aceh 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 Mobil Aceh has a NPV value higher than Zero then finance managers at Mobil Aceh 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 Mobil Aceh, then the stock price of the Mobil Aceh 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 Mobil Aceh 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 can impact the cash flow of the project.

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.

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 Mobil in Aceh, Indonesia (A)

References & Further Readings

Henri-Claude De Bettignies, Liana Downey (2018), "Mobil in Aceh, Indonesia (A) Harvard Business Review Case Study. Published by HBR Publications.


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