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Corruption in Germany 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 Corruption in Germany case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Corruption in Germany case study is a Harvard Business School (HBR) case study written by Rawi Abdelal, Rafael Di Tella, Jonathan Schlefer. The Corruption in Germany (referred as “Corruption Basf” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Cross-cultural management, Design, Ethics.

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 Corruption in Germany Case Study


Why do managers become corrupt? Does corruption ever pay? When do friendly relations cross into bribery? How can CEOs manage and prevent outbreaks of corruption? These and other questions are raised by three short case studies of corruption in Germany: at the global engineering firm Siemens, the automaker VW, and the chemical giant BASF. While German law not only permitted overseas bribery but even made it tax deductible until 1999, it was not welcomed in some nations where Siemens did business such as the United States-or in Germany after 2000-but old practices continued. Cooperative management-labor relations, often seen as key to the post-World War II German industrial powerhouse, went sour at VW, as a top manager secured key concessions by paying for union leaders' lavish foreign travel and visits to prostitutes. After vitamin prices sagged in the late 1980s, BASF and the Swiss chemical firm Hoffmann-La Roche plotted a global cartel that lasted a decade and raised the prices of many vitamins 50 percent or more. In the end, even after record criminal fines and jail time for some executives, some observers argued, such practices were likely to recur.


Case Authors : Rawi Abdelal, Rafael Di Tella, Jonathan Schlefer

Topic : Global Business

Related Areas : Cross-cultural management, Design, Ethics




Calculating Net Present Value (NPV) at 6% for Corruption in Germany Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10016596) -10016596 - -
Year 1 3456314 -6560282 3456314 0.9434 3260674
Year 2 3963397 -2596885 7419711 0.89 3527409
Year 3 3971033 1374148 11390744 0.8396 3334156
Year 4 3246906 4621054 14637650 0.7921 2571854
TOTAL 14637650 12694092




The Net Present Value at 6% discount rate is 2677496

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

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. Corruption Basf 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 Corruption Basf 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 Corruption in Germany

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 Corruption Basf 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 Corruption Basf 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 (10016596) -10016596 - -
Year 1 3456314 -6560282 3456314 0.8696 3005490
Year 2 3963397 -2596885 7419711 0.7561 2996898
Year 3 3971033 1374148 11390744 0.6575 2611019
Year 4 3246906 4621054 14637650 0.5718 1856429
TOTAL 10469836


The Net NPV after 4 years is 453240

(10469836 - 10016596 )








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 (10016596) -10016596 - -
Year 1 3456314 -6560282 3456314 0.8333 2880262
Year 2 3963397 -2596885 7419711 0.6944 2752359
Year 3 3971033 1374148 11390744 0.5787 2298052
Year 4 3246906 4621054 14637650 0.4823 1565830
TOTAL 9496503


The Net NPV after 4 years is -520093

At 20% discount rate the NPV is negative (9496503 - 10016596 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Corruption Basf 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 Corruption Basf has a NPV value higher than Zero then finance managers at Corruption Basf 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 Corruption Basf, then the stock price of the Corruption Basf 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 Corruption Basf 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.

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.

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.

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 Corruption in Germany

References & Further Readings

Rawi Abdelal, Rafael Di Tella, Jonathan Schlefer (2018), "Corruption in Germany Harvard Business Review Case Study. Published by HBR Publications.


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