RBC Financial Group--The Equator Principles in Qatargas II LNG Project 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 RBC Financial Group--The Equator Principles in Qatargas II LNG Project case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. RBC Financial Group--The Equator Principles in Qatargas II LNG Project case study is a Harvard Business School (HBR) case study written by Robert Klassen, Matias Gancberg. The RBC Financial Group--The Equator Principles in Qatargas II LNG Project (referred as “Rbc Qatargas” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, International business, Strategy, Sustainability.

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 RBC Financial Group--The Equator Principles in Qatargas II LNG Project Case Study

The environmental manager at the Royal Bank of Canada (RBC) has finally received the detailed environmental and social risk assessment of the Qatargas II LNG Project. RBC was a potential participant in a syndicated loan for a project financing venture in Qatar. The project would extract and process liquid natural gas there and transport it to the United Kingdom market. RBC was among the first banks to use an environmental and social risk assessment process based on the Equator Principles that supported the principles underlying sustainable development. However, environmental non-government organizations (NGOs) further complicated any financing decision; they were only too quick to point out publicly any shortcomings. Moreover, it was not clear if problems might occur in monitoring and enforcing any loan covenants. Two basic questions remained: first, does the Qatargas II Project make sense to RBC as it attempts to balance economic, environmental, and social performance (i.e., the triple-bottom line); and second, do the Equator Principles provide a competitive advantage?

Case Authors : Robert Klassen, Matias Gancberg

Topic : Global Business

Related Areas : International business, Strategy, Sustainability

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Calculating Net Present Value (NPV) at 6% for RBC Financial Group--The Equator Principles in Qatargas II LNG Project Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10004438)	-10004438	-	-
Year 1	3455246	-6549192	3455246	0.9434	3259666
Year 2	3980115	-2569077	7435361	0.89	3542288
Year 3	3937754	1368677	11373115	0.8396	3306214
Year 4	3236809	4605486	14609924	0.7921	2563856
TOTAL			14609924		12672024

The Net Present Value at 6% discount rate is 2667586

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. Rbc Qatargas 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 Rbc Qatargas 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 RBC Financial Group--The Equator Principles in Qatargas II LNG Project

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 Rbc Qatargas 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 Rbc Qatargas 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	(10004438)	-10004438	-	-
Year 1	3455246	-6549192	3455246	0.8696	3004562
Year 2	3980115	-2569077	7435361	0.7561	3009539
Year 3	3937754	1368677	11373115	0.6575	2589137
Year 4	3236809	4605486	14609924	0.5718	1850656
TOTAL					10453894

The Net NPV after 4 years is 449456

(10453894 - 10004438 )

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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	(10004438)	-10004438	-	-
Year 1	3455246	-6549192	3455246	0.8333	2879372
Year 2	3980115	-2569077	7435361	0.6944	2763969
Year 3	3937754	1368677	11373115	0.5787	2278793
Year 4	3236809	4605486	14609924	0.4823	1560961
TOTAL					9483094

The Net NPV after 4 years is -521344

At 20% discount rate the NPV is negative (9483094 - 10004438 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Rbc Qatargas 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 Rbc Qatargas has a NPV value higher than Zero then finance managers at Rbc Qatargas 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 Rbc Qatargas, then the stock price of the Rbc Qatargas 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 Rbc Qatargas 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 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.

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

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 RBC Financial Group--The Equator Principles in Qatargas II LNG Project

References & Further Readings

Robert Klassen, Matias Gancberg (2018), "RBC Financial Group--The Equator Principles in Qatargas II LNG Project Harvard Business Review Case Study. Published by HBR Publications.