Professionalization of Ujwal Bharati 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 Professionalization of Ujwal Bharati case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Professionalization of Ujwal Bharati case study is a Harvard Business School (HBR) case study written by K. Ramachandran. The Professionalization of Ujwal Bharati (referred as “Director's Ujwal” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Succession planning.

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 Professionalization of Ujwal Bharati Case Study

The case is woven around the decision dilemma faced by the second generation managing director of Ujwal Bharati Pharmaceuticals, a mid-size business. He had to decide whether to retain his non-family CEO or not. There are other issues related to corporate and family governance covered in the case as well. This case was written in the context of the major efforts made by Indian family businesses in recent years to professionalize their operations. This is particularly so among mid-size businesses. In this case, while the director appreciates the need to professionalize and successfully recruit non-family professionals, he is not able to retain them. The director's major dilemma is not only to delegate but to simultaneously find a way of making use of his time. Indirect opposition to changes from the old guard causes problems and the board, consisting of professionals, is ineffective. The director's elder brother, without any male heir, is non-interfering and the director's only son is not well-groomed for the position. The case is best suited for a session on professionalization of management of a growing company but is also appropriate for courses such as family businesses, organizational behavior, strategy implementation and entrepreneurship.

Case Authors : K. Ramachandran

Topic : Global Business

Related Areas : Succession planning

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Calculating Net Present Value (NPV) at 6% for Professionalization of Ujwal Bharati Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10008137)	-10008137	-	-
Year 1	3457130	-6551007	3457130	0.9434	3261443
Year 2	3972395	-2578612	7429525	0.89	3535417
Year 3	3962794	1384182	11392319	0.8396	3327238
Year 4	3222576	4606758	14614895	0.7921	2552582
TOTAL			14614895		12676681

The Net Present Value at 6% discount rate is 2668544

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. Net Present Value
2. Payback Period
3. Profitability Index
4. Internal Rate of Return

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. Director's Ujwal 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 Director's Ujwal 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 Professionalization of Ujwal Bharati

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 Director's Ujwal 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 Director's Ujwal 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	(10008137)	-10008137	-	-
Year 1	3457130	-6551007	3457130	0.8696	3006200
Year 2	3972395	-2578612	7429525	0.7561	3003701
Year 3	3962794	1384182	11392319	0.6575	2605601
Year 4	3222576	4606758	14614895	0.5718	1842518
TOTAL					10458021

The Net NPV after 4 years is 449884

(10458021 - 10008137 )

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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	(10008137)	-10008137	-	-
Year 1	3457130	-6551007	3457130	0.8333	2880942
Year 2	3972395	-2578612	7429525	0.6944	2758608
Year 3	3962794	1384182	11392319	0.5787	2293284
Year 4	3222576	4606758	14614895	0.4823	1554097
TOTAL					9486930

The Net NPV after 4 years is -521207

At 20% discount rate the NPV is negative (9486930 - 10008137 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Director's Ujwal 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 Director's Ujwal has a NPV value higher than Zero then finance managers at Director's Ujwal 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 Director's Ujwal, then the stock price of the Director's Ujwal 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 Director's Ujwal 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 –

Understanding of risks involved in the project.

What can impact the cash flow of 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 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.

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Negotiation Strategy of Professionalization of Ujwal Bharati

References & Further Readings

K. Ramachandran (2018), "Professionalization of Ujwal Bharati Harvard Business Review Case Study. Published by HBR Publications.