TCS: An Entrepreneurial Air-Express Company in Pakistan 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 TCS: An Entrepreneurial Air-Express Company in Pakistan case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. TCS: An Entrepreneurial Air-Express Company in Pakistan case study is a Harvard Business School (HBR) case study written by Walter Kuemmerle, Zahid Ahmed. The TCS: An Entrepreneurial Air-Express Company in Pakistan (referred as “Awan Tcs” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Business models, Emerging markets, Entrepreneurial finance, Growth 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 TCS: An Entrepreneurial Air-Express Company in Pakistan Case Study

Introduces Khalid Awan, co-founder of TCS, an entrepreneurial air-express company in Pakistan. Awan has succeeded in building a sizeable company despite serious obstacles, including pressure from the public postal system, an environment prone to corruption, and a nonexistent market for venture capital. The firm largely followed an organic financing strategy and made extensive use of leasing contracts. However, in the aftermath of September 11, 2001, Awan is now faced with a number of questions regarding further expansion of the firm. The tragic events of September 11 will most likely put pressure on the firm's revenues and create considerable uncertainty. Awan is also starting to think about diversification of his personal wealth, which is concentrated almost entirely in TCS. Decisions on all these issues will impact the firm's future financing policies and growth.

Case Authors : Walter Kuemmerle, Zahid Ahmed

Topic : Innovation & Entrepreneurship

Related Areas : Business models, Emerging markets, Entrepreneurial finance, Growth strategy

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Calculating Net Present Value (NPV) at 6% for TCS: An Entrepreneurial Air-Express Company in Pakistan Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10023914)	-10023914	-	-
Year 1	3468272	-6555642	3468272	0.9434	3271955
Year 2	3960970	-2594672	7429242	0.89	3525249
Year 3	3969139	1374467	11398381	0.8396	3332566
Year 4	3223818	4598285	14622199	0.7921	2553566
TOTAL			14622199		12683335

The Net Present Value at 6% discount rate is 2659421

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. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Awan Tcs 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 Awan Tcs have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of TCS: An Entrepreneurial Air-Express Company in Pakistan

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 Awan Tcs 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 Awan Tcs 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	(10023914)	-10023914	-	-
Year 1	3468272	-6555642	3468272	0.8696	3015889
Year 2	3960970	-2594672	7429242	0.7561	2995062
Year 3	3969139	1374467	11398381	0.6575	2609773
Year 4	3223818	4598285	14622199	0.5718	1843228
TOTAL					10463953

The Net NPV after 4 years is 440039

(10463953 - 10023914 )

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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	(10023914)	-10023914	-	-
Year 1	3468272	-6555642	3468272	0.8333	2890227
Year 2	3960970	-2594672	7429242	0.6944	2750674
Year 3	3969139	1374467	11398381	0.5787	2296955
Year 4	3223818	4598285	14622199	0.4823	1554696
TOTAL					9492552

The Net NPV after 4 years is -531362

At 20% discount rate the NPV is negative (9492552 - 10023914 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Awan Tcs 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 Awan Tcs has a NPV value higher than Zero then finance managers at Awan Tcs 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 Awan Tcs, then the stock price of the Awan Tcs 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 Awan Tcs 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 can impact the cash flow of the project.

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 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 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.

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Negotiation Strategy of TCS: An Entrepreneurial Air-Express Company in Pakistan

References & Further Readings

Walter Kuemmerle, Zahid Ahmed (2018), "TCS: An Entrepreneurial Air-Express Company in Pakistan Harvard Business Review Case Study. Published by HBR Publications.