Mohamed Azab and Seha 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 Mohamed Azab and Seha Capital case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Mohamed Azab and Seha Capital case study is a Harvard Business School (HBR) case study written by Richard G. Hamermesh, Sarah McAra. The Mohamed Azab and Seha Capital (referred as “Azab Hassab” 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, Financial management, Health.

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 Mohamed Azab and Seha Capital Case Study

In January 2011, Mohamed Azab, founder and CEO of health care investment firm Seha Capital, made his first health care investment in Hassab Labs, a diagnostic lab in Alexandria, Egypt. Weeks later, a revolution erupted across the country as the Arab Spring swept through the region, and Azab spent the following years active in both the protests and in restructuring and expanding Hassab Labs. From 2011 to 2014, he opened 25 new branches, quadrupled staff, and more than doubled net income. By the end of the revolution in 2014, Hassab Labs was among the top five chains in the country. In October 2014, Seha partially exited Hassab Labs in a sale to an African conglomerate, SAHAM Group. At the same time, Azab learned that foreign investors in a small private hospital in Egypt were looking to exit the market. While Seha's mission was to build diagnostic, hospital, and pharmacy chains in Egypt, Azab had not been planning to enter the hospital market until he further expanded the diagnostic labs. In late 2014, Azab must decide if he should focus on expanding Hassab Labs, either in Egypt or across Africa, or invest in the hospital.

Case Authors : Richard G. Hamermesh, Sarah McAra

Topic : Innovation & Entrepreneurship

Related Areas : Entrepreneurship, Financial management, Health

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Calculating Net Present Value (NPV) at 6% for Mohamed Azab and Seha Capital Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10017421)	-10017421	-	-
Year 1	3462483	-6554938	3462483	0.9434	3266493
Year 2	3953032	-2601906	7415515	0.89	3518184
Year 3	3948890	1346984	11364405	0.8396	3315564
Year 4	3230953	4577937	14595358	0.7921	2559217
TOTAL			14595358		12659459

The Net Present Value at 6% discount rate is 2642038

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. Profitability Index
3. Payback Period
4. Net Present Value

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. Azab Hassab 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 Azab Hassab 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 Mohamed Azab and Seha 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 Azab Hassab 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 Azab Hassab 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	(10017421)	-10017421	-	-
Year 1	3462483	-6554938	3462483	0.8696	3010855
Year 2	3953032	-2601906	7415515	0.7561	2989060
Year 3	3948890	1346984	11364405	0.6575	2596459
Year 4	3230953	4577937	14595358	0.5718	1847308
TOTAL					10443682

The Net NPV after 4 years is 426261

(10443682 - 10017421 )

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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	(10017421)	-10017421	-	-
Year 1	3462483	-6554938	3462483	0.8333	2885403
Year 2	3953032	-2601906	7415515	0.6944	2745161
Year 3	3948890	1346984	11364405	0.5787	2285237
Year 4	3230953	4577937	14595358	0.4823	1558137
TOTAL					9473938

The Net NPV after 4 years is -543483

At 20% discount rate the NPV is negative (9473938 - 10017421 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Azab Hassab 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 Azab Hassab has a NPV value higher than Zero then finance managers at Azab Hassab 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 Azab Hassab, then the stock price of the Azab Hassab 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 Azab Hassab 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.

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.

Understanding of risks involved in the project.

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 Mohamed Azab and Seha Capital

References & Further Readings

Richard G. Hamermesh, Sarah McAra (2018), "Mohamed Azab and Seha Capital Harvard Business Review Case Study. Published by HBR Publications.