GreenWood Resources: A Global Sustainable Venture in the Making 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 GreenWood Resources: A Global Sustainable Venture in the Making case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. GreenWood Resources: A Global Sustainable Venture in the Making case study is a Harvard Business School (HBR) case study written by Lei Li, Howard Feldman, Alan Eisner. The GreenWood Resources: A Global Sustainable Venture in the Making (referred as “Greenwood Jeff” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Social responsibility, Sustainability.

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 GreenWood Resources: A Global Sustainable Venture in the Making Case Study

GreenWood Resources Inc. was founded in 1998 by Jeff Nuss, a bio-resources engineer. It was a Portland, Oregon, USA-based investment and asset management company with a worldwide focus on high-yield and fast-growing tree farms. In spite of its global vision, value proposition and pursuit of environmental stewardship and social responsibility, GreenWood had struggled for almost 10 years to obtain significant investment funds until 2007-2008. Through persistent effort, GreenWood built the key elements (people, resources and business networks) for a successful venture despite the serious early financial constraints. GreenWood entered and navigated the Chinese market, deciding to establish its China operation with only a fraction of the funds it needed. Jeff seized an opportunity to organize a US$175 million private equity fund through his connections with the timber investment community to acquire a large poplar plantation in Oregon. The expanded scale and personnel resulting from the acquisition enabled GreenWood to become a visible player in the tree plantation industry and facilitated its securing an additional commitment of US$200 million of capital for use in the Chinese market. Notwithstanding the availability of the capital and its cumulative knowledge of the Chinese market, the investment screening and negotiation process in China turned out to be complex due to the differences in business approaches and culturally embedded mindsets. In June 2010, Jeff and his team were weighing the pros and cons of two potential projects. They felt that GreenWood needed to proceed carefully to ensure its criteria of sustainable business (in terms of economic performance, social responsibility and environmental stewardship) were met in China but also realized the company should show some progress to its major investor in China, Oriental Timber Fund Limited. Jeff and his senior management team needed to decide whether they should recommend investing in one of the two projects.

Case Authors : Lei Li, Howard Feldman, Alan Eisner

Topic : Global Business

Related Areas : Social responsibility, Sustainability

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Calculating Net Present Value (NPV) at 6% for GreenWood Resources: A Global Sustainable Venture in the Making Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10000339)	-10000339	-	-
Year 1	3449967	-6550372	3449967	0.9434	3254686
Year 2	3978971	-2571401	7428938	0.89	3541270
Year 3	3960379	1388978	11389317	0.8396	3325211
Year 4	3247809	4636787	14637126	0.7921	2572569
TOTAL			14637126		12693735

The Net Present Value at 6% discount rate is 2693396

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. Profitability Index
2. Net Present Value
3. Payback Period
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. Timing of the expected cash flows – stockholders of Greenwood Jeff 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. Greenwood Jeff 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 GreenWood Resources: A Global Sustainable Venture in the Making

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 Greenwood Jeff 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 Greenwood Jeff 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	(10000339)	-10000339	-	-
Year 1	3449967	-6550372	3449967	0.8696	2999971
Year 2	3978971	-2571401	7428938	0.7561	3008674
Year 3	3960379	1388978	11389317	0.6575	2604013
Year 4	3247809	4636787	14637126	0.5718	1856945
TOTAL					10469604

The Net NPV after 4 years is 469265

(10469604 - 10000339 )

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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	(10000339)	-10000339	-	-
Year 1	3449967	-6550372	3449967	0.8333	2874973
Year 2	3978971	-2571401	7428938	0.6944	2763174
Year 3	3960379	1388978	11389317	0.5787	2291886
Year 4	3247809	4636787	14637126	0.4823	1566266
TOTAL					9496299

The Net NPV after 4 years is -504040

At 20% discount rate the NPV is negative (9496299 - 10000339 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Greenwood Jeff 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 Greenwood Jeff has a NPV value higher than Zero then finance managers at Greenwood Jeff 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 Greenwood Jeff, then the stock price of the Greenwood Jeff 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 Greenwood Jeff 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 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.

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.

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Negotiation Strategy of GreenWood Resources: A Global Sustainable Venture in the Making

References & Further Readings

Lei Li, Howard Feldman, Alan Eisner (2018), "GreenWood Resources: A Global Sustainable Venture in the Making Harvard Business Review Case Study. Published by HBR Publications.