Saudi Aramco and Corporate Venture Capital 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 Saudi Aramco and Corporate Venture Capital case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Saudi Aramco and Corporate Venture Capital case study is a Harvard Business School (HBR) case study written by Joseph Fuller, Matthew Rhodes-Kropf, Nathaniel Burbank. The Saudi Aramco and Corporate Venture Capital (referred as “Saudi Aramco's” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, .

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 Saudi Aramco and Corporate Venture Capital Case Study

Saudi Aramco launched an internal venture capital arm in 2011, which promptly became the world's largest investor in energy related startups. In choosing to proceed, the company's New Business Development unit (NPD) wrestled with a number of challenges. How should the fund be structured, as a fully independent, venture capital partnership or as a business unit? How should it be governed, and how should the investment committee function? Could mechanisms be developed that ensured the expertise of Saudi Aramco's famously conservative engineering resources could be harnessed in the investment process and its business units enlisted to work with portfolio companies? How could the fund be structured to reflect Saudi Aramco's role in modernizing the economy of Saudi Arabia? The case provides a vehicle for discussing the basics of corporate venture capital and the challenges large corporations face in participating in the world of startups. It also describes how certain industries, like energy, are poorly suited to the investment profile of traditional venture capitalists. The product development cycle is too long and the capital required to develop and test products too great for ordinary, general partnerships to sustain. The case also introduces interesting themes in the role of parastatals in contributing to national economic competitiveness.

Case Authors : Joseph Fuller, Matthew Rhodes-Kropf, Nathaniel Burbank

Topic : Innovation & Entrepreneurship

Related Areas :

Calculating Net Present Value (NPV) at 6% for Saudi Aramco and Corporate Venture Capital Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10029606) -10029606 - -
Year 1 3455706 -6573900 3455706 0.9434 3260100
Year 2 3972704 -2601196 7428410 0.89 3535692
Year 3 3961887 1360691 11390297 0.8396 3326477
Year 4 3223058 4583749 14613355 0.7921 2552964
TOTAL 14613355 12675233

The Net Present Value at 6% discount rate is 2645627

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. Profitability Index
2. Payback Period
3. Net Present Value
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 Saudi Aramco's 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. Saudi Aramco's shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

Formula and Steps to Calculate Net Present Value (NPV) of Saudi Aramco and Corporate Venture Capital

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 Saudi Aramco's 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 Saudi Aramco's 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 %
Cash Flows
Year 0 (10029606) -10029606 - -
Year 1 3455706 -6573900 3455706 0.8696 3004962
Year 2 3972704 -2601196 7428410 0.7561 3003935
Year 3 3961887 1360691 11390297 0.6575 2605005
Year 4 3223058 4583749 14613355 0.5718 1842794
TOTAL 10456696

The Net NPV after 4 years is 427090

(10456696 - 10029606 )

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 %
Cash Flows
Year 0 (10029606) -10029606 - -
Year 1 3455706 -6573900 3455706 0.8333 2879755
Year 2 3972704 -2601196 7428410 0.6944 2758822
Year 3 3961887 1360691 11390297 0.5787 2292759
Year 4 3223058 4583749 14613355 0.4823 1554330
TOTAL 9485666

The Net NPV after 4 years is -543940

At 20% discount rate the NPV is negative (9485666 - 10029606 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Saudi Aramco's 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 Saudi Aramco's has a NPV value higher than Zero then finance managers at Saudi Aramco's 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 Saudi Aramco's, then the stock price of the Saudi Aramco's 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 Saudi Aramco's 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 can impact the cash flow of 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.

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

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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.

References & Further Readings

Joseph Fuller, Matthew Rhodes-Kropf, Nathaniel Burbank (2018), "Saudi Aramco and Corporate Venture Capital Harvard Business Review Case Study. Published by HBR Publications.