Jamaica's Anemic Growth: The IMF, China and the Debt(th) Trap 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 Jamaica's Anemic Growth: The IMF, China and the Debt(th) Trap case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Jamaica's Anemic Growth: The IMF, China and the Debt(th) Trap case study is a Harvard Business School (HBR) case study written by Rafael Di Tella, Natalie Kindred. The Jamaica's Anemic Growth: The IMF, China and the Debt(th) Trap (referred as “Imf Jamaica” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Economic development, Emerging markets, Ethics, Financial management, Globalization, National competitiveness, Policy, Risk management.

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 Jamaica's Anemic Growth: The IMF, China and the Debt(th) Trap Case Study

This case describes the economic development problems faced by the small Caribbean-island country of Jamaica over most of the past half-century. The Jamaican economy showed relatively strong growth in the 1960s but stagnated in the 1970s. By the end of that decade, Jamaica was forced to turn to the International Monetary Fund (IMF) for balance-of-payments support. Over the 1980s and early 1990s, the unpopular policy conditions associated with IMF loan programs made the Fund a lightning rod for criticism over Jamaica's lack of economic progress. Jamaicans celebrated the end of IMF borrowing in the mid-1990s, but a severe financial crisis later that decade created a new layer of economic problems. In 2010, in the context of the global economic downturn, Jamaica once again returned to the IMF for financing support. This case allows students to explore the complicated economic difficulties faced by Jamaica, which remains burdened by a self-reinforcing set of interrelated factors, including high public debt, a sluggish private sector, an inefficient public sector, poverty, and crime, among others.

Case Authors : Rafael Di Tella, Natalie Kindred

Topic : Global Business

Related Areas : Economic development, Emerging markets, Ethics, Financial management, Globalization, National competitiveness, Policy, Risk management

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Calculating Net Present Value (NPV) at 6% for Jamaica's Anemic Growth: The IMF, China and the Debt(th) Trap Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10024675)	-10024675	-	-
Year 1	3454690	-6569985	3454690	0.9434	3259142
Year 2	3976721	-2593264	7431411	0.89	3539268
Year 3	3958767	1365503	11390178	0.8396	3323857
Year 4	3230610	4596113	14620788	0.7921	2558946
TOTAL			14620788		12681212

The Net Present Value at 6% discount rate is 2656537

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. Payback Period
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. Imf Jamaica 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 Imf Jamaica 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 Jamaica's Anemic Growth: The IMF, China and the Debt(th) Trap

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 Imf Jamaica 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 Imf Jamaica 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	(10024675)	-10024675	-	-
Year 1	3454690	-6569985	3454690	0.8696	3004078
Year 2	3976721	-2593264	7431411	0.7561	3006972
Year 3	3958767	1365503	11390178	0.6575	2602954
Year 4	3230610	4596113	14620788	0.5718	1847112
TOTAL					10461116

The Net NPV after 4 years is 436441

(10461116 - 10024675 )

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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	(10024675)	-10024675	-	-
Year 1	3454690	-6569985	3454690	0.8333	2878908
Year 2	3976721	-2593264	7431411	0.6944	2761612
Year 3	3958767	1365503	11390178	0.5787	2290953
Year 4	3230610	4596113	14620788	0.4823	1557972
TOTAL					9489445

The Net NPV after 4 years is -535230

At 20% discount rate the NPV is negative (9489445 - 10024675 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Imf Jamaica 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 Imf Jamaica has a NPV value higher than Zero then finance managers at Imf Jamaica 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 Imf Jamaica, then the stock price of the Imf Jamaica 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 Imf Jamaica 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.

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

Understanding of risks involved in 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 Jamaica's Anemic Growth: The IMF, China and the Debt(th) Trap

References & Further Readings

Rafael Di Tella, Natalie Kindred (2018), "Jamaica's Anemic Growth: The IMF, China and the Debt(th) Trap Harvard Business Review Case Study. Published by HBR Publications.