Liberalising the Postal Service in Hong Kong Post 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 Liberalising the Postal Service in Hong Kong Post case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Liberalising the Postal Service in Hong Kong Post case study is a Harvard Business School (HBR) case study written by Ka-Fu Wong, Carola Ramon-Berjano. The Liberalising the Postal Service in Hong Kong Post (referred as “Postal Post” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Economy, Government, International business.

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 Liberalising the Postal Service in Hong Kong Post Case Study

Postal services throughout the world are undergoing a process of liberalization and privatization. Competition is getting tougher, as the traditional letter market is shrinking in the wake of a plethora of alternatives. In Hong Kong, the post office became a trading fund in 1995. This allowed for more flexible management of the business as it became self-financing, although it remained a government office. Is the Hong Kong Post better prepared to face the new challenges and opportunities after its transformation into a trading fund or is it better off being a state-run office?

Case Authors : Ka-Fu Wong, Carola Ramon-Berjano

Topic : Global Business

Related Areas : Economy, Government, International business

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Calculating Net Present Value (NPV) at 6% for Liberalising the Postal Service in Hong Kong Post Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10004313)	-10004313	-	-
Year 1	3445267	-6559046	3445267	0.9434	3250252
Year 2	3966533	-2592513	7411800	0.89	3530200
Year 3	3964700	1372187	11376500	0.8396	3328839
Year 4	3226414	4598601	14602914	0.7921	2555622
TOTAL			14602914		12664913

The Net Present Value at 6% discount rate is 2660600

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. Timing of the expected cash flows – stockholders of Postal Post have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Postal Post shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Liberalising the Postal Service in Hong Kong Post

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 Postal Post 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 Postal Post 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	(10004313)	-10004313	-	-
Year 1	3445267	-6559046	3445267	0.8696	2995884
Year 2	3966533	-2592513	7411800	0.7561	2999269
Year 3	3964700	1372187	11376500	0.6575	2606855
Year 4	3226414	4598601	14602914	0.5718	1844713
TOTAL					10446720

The Net NPV after 4 years is 442407

(10446720 - 10004313 )

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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	(10004313)	-10004313	-	-
Year 1	3445267	-6559046	3445267	0.8333	2871056
Year 2	3966533	-2592513	7411800	0.6944	2754537
Year 3	3964700	1372187	11376500	0.5787	2294387
Year 4	3226414	4598601	14602914	0.4823	1555948
TOTAL					9475927

The Net NPV after 4 years is -528386

At 20% discount rate the NPV is negative (9475927 - 10004313 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Postal Post 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 Postal Post has a NPV value higher than Zero then finance managers at Postal Post 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 Postal Post, then the stock price of the Postal Post 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 Postal Post 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 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.

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.

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 Liberalising the Postal Service in Hong Kong Post

References & Further Readings

Ka-Fu Wong, Carola Ramon-Berjano (2018), "Liberalising the Postal Service in Hong Kong Post Harvard Business Review Case Study. Published by HBR Publications.