International Lobbying and The Dow Chemical Company (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 International Lobbying and The Dow Chemical Company (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. International Lobbying and The Dow Chemical Company (A) case study is a Harvard Business School (HBR) case study written by Arthur A. Daemmrich. The International Lobbying and The Dow Chemical Company (A) (referred as “Chemical Lobbying” 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, Product development, Public relations.

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 International Lobbying and The Dow Chemical Company (A) Case Study

This case explores company strategy, business-government relations, and collective action challenges associated with international and domestic lobbying regarding regulation of the chemical industry. In the fall of 2006, a five-year legislative process for a major new law regulating chemicals in the European Union appeared to be nearing its conclusion. REACH, the Registration, Evaluation, Authorization, and Restriction of Chemicals, would create a new European Chemicals Agency, require companies to submit testing data on existing and new compounds, and restrict the manufacture of hazardous substances. Andrew Liveris, CEO of the Dow Chemical Company, has to decide whether the company should engage in direct discussions with the European Parliament and Commission, with the implication that the company can influence the regulations but also would have to support the final outcome. The case summarizes Dow's history, competitive dynamics in the sector, and regulation of the chemical industry before describing the REACH legislative process and various approaches to lobbying used by chemical companies, trade groups, and environmental NGOs.

Case Authors : Arthur A. Daemmrich

Topic : Global Business

Related Areas : International business, Product development, Public relations

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Calculating Net Present Value (NPV) at 6% for International Lobbying and The Dow Chemical Company (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10027112)	-10027112	-	-
Year 1	3447156	-6579956	3447156	0.9434	3252034
Year 2	3962774	-2617182	7409930	0.89	3526855
Year 3	3965416	1348234	11375346	0.8396	3329440
Year 4	3223957	4572191	14599303	0.7921	2553676
TOTAL			14599303		12662004

The Net Present Value at 6% discount rate is 2634892

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. Profitability Index
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. Chemical Lobbying 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 Chemical Lobbying 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 International Lobbying and The Dow Chemical Company (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 Chemical Lobbying 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 Chemical Lobbying 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	(10027112)	-10027112	-	-
Year 1	3447156	-6579956	3447156	0.8696	2997527
Year 2	3962774	-2617182	7409930	0.7561	2996426
Year 3	3965416	1348234	11375346	0.6575	2607325
Year 4	3223957	4572191	14599303	0.5718	1843308
TOTAL					10444587

The Net NPV after 4 years is 417475

(10444587 - 10027112 )

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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	(10027112)	-10027112	-	-
Year 1	3447156	-6579956	3447156	0.8333	2872630
Year 2	3962774	-2617182	7409930	0.6944	2751926
Year 3	3965416	1348234	11375346	0.5787	2294801
Year 4	3223957	4572191	14599303	0.4823	1554763
TOTAL					9474121

The Net NPV after 4 years is -552991

At 20% discount rate the NPV is negative (9474121 - 10027112 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Chemical Lobbying 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 Chemical Lobbying has a NPV value higher than Zero then finance managers at Chemical Lobbying 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 Chemical Lobbying, then the stock price of the Chemical Lobbying 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 Chemical Lobbying 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.

Understanding of risks involved in the project.

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 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.

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Negotiation Strategy of International Lobbying and The Dow Chemical Company (A)

References & Further Readings

Arthur A. Daemmrich (2018), "International Lobbying and The Dow Chemical Company (A) Harvard Business Review Case Study. Published by HBR Publications.