Vibhava Chemicals: Pursuit of a Cleaner Space 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 Vibhava Chemicals: Pursuit of a Cleaner Space case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Vibhava Chemicals: Pursuit of a Cleaner Space case study is a Harvard Business School (HBR) case study written by N Ramesh, N. Barnabus. The Vibhava Chemicals: Pursuit of a Cleaner Space (referred as “Vibhava Cleaning” 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, International business, Strategy.

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 Vibhava Chemicals: Pursuit of a Cleaner Space Case Study

In April 2011, Vithal Gambhir, the marketing director of Vibhava Chemicals (Vibhava), an entrepreneurial venture and leader in the black phenyl category in the home cleaning agents (HCA) market in South India, was faced with a marketing challenge. A slew of multi-national corporation (MNC) brands in the emerging new category of specialty cleaning agents had whittled down Vibhava's share of the traditional black phenyl category by 50 per cent over the previous eight years. The marketing efforts of the MNCs had also led to a gradual transformation of the HCA market, expanding and segmenting it in terms of applications (e.g. floor-cleaning agents and toilet-cleaning agents) and benefits (e.g. disinfecting, cleaning and deodorizing). As a result, Vibhava's leading brand, 'Black Belt' black phenyl disinfectant, began losing ground in the market. Vibhava had successfully responded to this decline by launching Ozone, a pine-oil-based floor cleaner, in 2003. Positioned as an herbal, eco-friendly, deodorizing floor cleaner, Ozone managed to keep out of the way of Domex, the leading MNC brand of disinfecting floor cleaner; however, during the last couple of years Domex had been available in many variants serving many segments and the market became flooded with both MNC and established Indian brands. While the sale of Ozone rose in absolute terms, Vibhava's share in the growing home cleaning market dropped from 25 per cent in a predominantly traditional product market in the 1990s, to 11 per cent in the transformed market of 2010. Gambhir now faced the daunting challenge of meeting an ambitious sales target of INR1 billion for 2011/12, which was double the sales of the previous year.

Case Authors : N Ramesh, N. Barnabus

Topic : Innovation & Entrepreneurship

Related Areas : Entrepreneurship, International business, Strategy

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Calculating Net Present Value (NPV) at 6% for Vibhava Chemicals: Pursuit of a Cleaner Space Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10001061)	-10001061	-	-
Year 1	3451703	-6549358	3451703	0.9434	3256324
Year 2	3977576	-2571782	7429279	0.89	3540028
Year 3	3957891	1386109	11387170	0.8396	3323122
Year 4	3243602	4629711	14630772	0.7921	2569237
TOTAL			14630772		12688710

The Net Present Value at 6% discount rate is 2687649

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 Vibhava Cleaning 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. Vibhava Cleaning 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 Vibhava Chemicals: Pursuit of a Cleaner Space

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 Vibhava Cleaning 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 Vibhava Cleaning 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	(10001061)	-10001061	-	-
Year 1	3451703	-6549358	3451703	0.8696	3001481
Year 2	3977576	-2571782	7429279	0.7561	3007619
Year 3	3957891	1386109	11387170	0.6575	2602378
Year 4	3243602	4629711	14630772	0.5718	1854540
TOTAL					10466017

The Net NPV after 4 years is 464956

(10466017 - 10001061 )

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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	(10001061)	-10001061	-	-
Year 1	3451703	-6549358	3451703	0.8333	2876419
Year 2	3977576	-2571782	7429279	0.6944	2762206
Year 3	3957891	1386109	11387170	0.5787	2290446
Year 4	3243602	4629711	14630772	0.4823	1564237
TOTAL					9493308

The Net NPV after 4 years is -507753

At 20% discount rate the NPV is negative (9493308 - 10001061 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Vibhava Cleaning 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 Vibhava Cleaning has a NPV value higher than Zero then finance managers at Vibhava Cleaning 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 Vibhava Cleaning, then the stock price of the Vibhava Cleaning 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 Vibhava Cleaning 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 can impact the cash flow of the project.

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

Understanding of risks involved in 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 Vibhava Chemicals: Pursuit of a Cleaner Space

References & Further Readings

N Ramesh, N. Barnabus (2018), "Vibhava Chemicals: Pursuit of a Cleaner Space Harvard Business Review Case Study. Published by HBR Publications.