China Versus Japan: On the Verge of a Trade War 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 China Versus Japan: On the Verge of a Trade War case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. China Versus Japan: On the Verge of a Trade War case study is a Harvard Business School (HBR) case study written by Carola Ramon-Berjano, Ka-Fu Wong, Hitomi Iizaka. The China Versus Japan: On the Verge of a Trade War (referred as “Wto Dispute” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Policy.

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 China Versus Japan: On the Verge of a Trade War Case Study

In April 2001, Japan curbed imports on three Chinese farm products--fresh shiitake mushrooms, rushes for grass mats, and Chinese onions. In retaliation, in June 2001 China imposed a 100% punitive tariff on imports of three Japanese export products--motor vehicles, mobile phones, and air conditioners. Japan was accused of violating WTO rules. The dispute was subsequently resolved, but given that China was not a WTO member at the time of the dispute, the dispute generated a lot of controversy regarding trade safeguard measures. Introduces students to the WTO dispute settlement mechanism and compares it to the old GATT system, and highlights the role of political interest groups in trade policy. Questions whether Japan had a case for citing their safeguard measures or was it just protecting its powerful shiitake mushroom farmers. In addition, questions whether WTO membership would in turn protect China from trade disputes such as this one.

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

Topic : Global Business

Related Areas : Policy

---

Calculating Net Present Value (NPV) at 6% for China Versus Japan: On the Verge of a Trade War Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10001558)	-10001558	-	-
Year 1	3461007	-6540551	3461007	0.9434	3265101
Year 2	3979324	-2561227	7440331	0.89	3541584
Year 3	3966331	1405104	11406662	0.8396	3330208
Year 4	3225785	4630889	14632447	0.7921	2555124
TOTAL			14632447		12692017

The Net Present Value at 6% discount rate is 2690459

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. 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. Wto Dispute 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 Wto Dispute 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 China Versus Japan: On the Verge of a Trade War

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 Wto Dispute 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 Wto Dispute 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	(10001558)	-10001558	-	-
Year 1	3461007	-6540551	3461007	0.8696	3009571
Year 2	3979324	-2561227	7440331	0.7561	3008941
Year 3	3966331	1405104	11406662	0.6575	2607927
Year 4	3225785	4630889	14632447	0.5718	1844353
TOTAL					10470792

The Net NPV after 4 years is 469234

(10470792 - 10001558 )

---

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	(10001558)	-10001558	-	-
Year 1	3461007	-6540551	3461007	0.8333	2884173
Year 2	3979324	-2561227	7440331	0.6944	2763419
Year 3	3966331	1405104	11406662	0.5787	2295330
Year 4	3225785	4630889	14632447	0.4823	1555645
TOTAL					9498567

The Net NPV after 4 years is -502991

At 20% discount rate the NPV is negative (9498567 - 10001558 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Wto Dispute 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 Wto Dispute has a NPV value higher than Zero then finance managers at Wto Dispute 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 Wto Dispute, then the stock price of the Wto Dispute 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 Wto Dispute 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.

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.

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.

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 China Versus Japan: On the Verge of a Trade War

References & Further Readings

Carola Ramon-Berjano, Ka-Fu Wong, Hitomi Iizaka (2018), "China Versus Japan: On the Verge of a Trade War Harvard Business Review Case Study. Published by HBR Publications.