Danimal in South Africa: Management Innovation at the Bottom of the Pyramid 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 Danimal in South Africa: Management Innovation at the Bottom of the Pyramid case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Danimal in South Africa: Management Innovation at the Bottom of the Pyramid case study is a Harvard Business School (HBR) case study written by Verity Hawarden, Helena Barnard. The Danimal in South Africa: Management Innovation at the Bottom of the Pyramid (referred as “Pyramid Danimal” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Entrepreneurship, Innovation.

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 Danimal in South Africa: Management Innovation at the Bottom of the Pyramid Case Study

The case focuses on management innovation in the South African dairy industry, describing how an innovative new yoghurt product, Danimal, was created specifically for the market at the base of the pyramid. It explains how management of the product line embodied the various innovation opportunities and challenges presented. The concept was initially introduced in order to assess the feasibility of profitably servicing this market. However, the project was not simply about introducing a cheap brand to poor people but was more about creating brand awareness in the market at the base of the pyramid. The new product took into consideration the nutritional shortcomings in the diet of children in this market and also allowed for the lack of available infrastructure - electricity and refrigeration. The case illustrates the importance of a product being affordable, relevant and available for this market. Innovation went further than product design and also took into account the necessity of a lean distribution channel. This took the form of micro-distributers, referred to as Danimamas, who comprised township residents, unemployed or part-time employed individuals. The case offers insights into the complexity of doing business in developing countries. The company admits that it has not been a sustainable business model in terms of current profitability but the value that has been gained from social marketing and long-term brand development has been great. The case concludes with the challenge of how to ensure that the project continues on its upward trajectory. The objectives of the case are to encourage students to have a better understanding of the strategies required to successfully impact on low-income markets in developing countries, the different metrics that one could consider when assessing the impact of interventions on the base of the pyramid market, and the importance of harnessing opportunities and overcoming the challenges of management innovation.

Case Authors : Verity Hawarden, Helena Barnard

Topic : Innovation & Entrepreneurship

Related Areas : Entrepreneurship, Innovation

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Calculating Net Present Value (NPV) at 6% for Danimal in South Africa: Management Innovation at the Bottom of the Pyramid Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10011305)	-10011305	-	-
Year 1	3466052	-6545253	3466052	0.9434	3269860
Year 2	3958566	-2586687	7424618	0.89	3523110
Year 3	3970744	1384057	11395362	0.8396	3333913
Year 4	3246942	4630999	14642304	0.7921	2571882
TOTAL			14642304		12698765

The Net Present Value at 6% discount rate is 2687460

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. Payback Period
2. Net Present Value
3. Internal Rate of Return
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. Timing of the expected cash flows – stockholders of Pyramid Danimal 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. Pyramid Danimal 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 Danimal in South Africa: Management Innovation at the Bottom of the Pyramid

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 Innovation & Entrepreneurship 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 Pyramid Danimal 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 Pyramid Danimal 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	(10011305)	-10011305	-	-
Year 1	3466052	-6545253	3466052	0.8696	3013958
Year 2	3958566	-2586687	7424618	0.7561	2993245
Year 3	3970744	1384057	11395362	0.6575	2610829
Year 4	3246942	4630999	14642304	0.5718	1856450
TOTAL					10474481

The Net NPV after 4 years is 463176

(10474481 - 10011305 )

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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	(10011305)	-10011305	-	-
Year 1	3466052	-6545253	3466052	0.8333	2888377
Year 2	3958566	-2586687	7424618	0.6944	2749004
Year 3	3970744	1384057	11395362	0.5787	2297884
Year 4	3246942	4630999	14642304	0.4823	1565848
TOTAL					9501113

The Net NPV after 4 years is -510192

At 20% discount rate the NPV is negative (9501113 - 10011305 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Pyramid Danimal 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 Pyramid Danimal has a NPV value higher than Zero then finance managers at Pyramid Danimal 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 Pyramid Danimal, then the stock price of the Pyramid Danimal 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 Pyramid Danimal 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 can impact the cash flow of 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 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 Danimal in South Africa: Management Innovation at the Bottom of the Pyramid

References & Further Readings

Verity Hawarden, Helena Barnard (2018), "Danimal in South Africa: Management Innovation at the Bottom of the Pyramid Harvard Business Review Case Study. Published by HBR Publications.