Educomp: Shaping Education in the New Millennium 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 Educomp: Shaping Education in the New Millennium case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Educomp: Shaping Education in the New Millennium case study is a Harvard Business School (HBR) case study written by Amita Mital, Sanjay Dhir, Sonjoy Mohanty. The Educomp: Shaping Education in the New Millennium (referred as “Educomp Education” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. 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

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Case Description of Educomp: Shaping Education in the New Millennium Case Study

Educomp Solutions Ltd. was established in 1994 with the aim of providing for a customer's entire education lifecycle, from pre-school to higher education/vocational training, and appropriating value from the same customer multiple times. This strategy, over a period of 17 years, enabled Educomp to become the largest player in the education technology sector in India. Educomp took the organic route to growth, which it achieved largely through acquisitions and alliances. Its flagship brand, SmartClass, brought technology into the classroom with a vast repository of digital modules on every subject. However, in 2012 the government of India proposed changes in its education policy that - along with the country's economic uncertainty - threatened to erode the competitive advantage that ESL had gained over the years. The CEO of Educomp wondered how he could maintain his organization's leadership position. He was contemplating a three-pronged strategy that involved 1) expanding into the untapped Indian rural market segment with school learning solutions; 2) creating a virtual learning solution that included open-source content for students; and 3) investing further in research and development in order to develop innovative products to penetrate the Indian education market. Author Amita Mital is affiliated with Indian Institute of Management Lucknow.

Case Authors : Amita Mital, Sanjay Dhir, Sonjoy Mohanty

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Educomp: Shaping Education in the New Millennium Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018873)	-10018873	-	-
Year 1	3444470	-6574403	3444470	0.9434	3249500
Year 2	3981987	-2592416	7426457	0.89	3543954
Year 3	3967759	1375343	11394216	0.8396	3331407
Year 4	3237340	4612683	14631556	0.7921	2564276
TOTAL			14631556		12689138

The Net Present Value at 6% discount rate is 2670265

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. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Educomp Education 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 Educomp Education 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 Educomp: Shaping Education in the New Millennium

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 Leadership & Managing People 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 Educomp Education 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 Educomp Education 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	(10018873)	-10018873	-	-
Year 1	3444470	-6574403	3444470	0.8696	2995191
Year 2	3981987	-2592416	7426457	0.7561	3010954
Year 3	3967759	1375343	11394216	0.6575	2608866
Year 4	3237340	4612683	14631556	0.5718	1850960
TOTAL					10465971

The Net NPV after 4 years is 447098

(10465971 - 10018873 )

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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	(10018873)	-10018873	-	-
Year 1	3444470	-6574403	3444470	0.8333	2870392
Year 2	3981987	-2592416	7426457	0.6944	2765269
Year 3	3967759	1375343	11394216	0.5787	2296157
Year 4	3237340	4612683	14631556	0.4823	1561217
TOTAL					9493034

The Net NPV after 4 years is -525839

At 20% discount rate the NPV is negative (9493034 - 10018873 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Educomp Education 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 Educomp Education has a NPV value higher than Zero then finance managers at Educomp Education 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 Educomp Education, then the stock price of the Educomp Education 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 Educomp Education 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.

Understanding of risks involved in the project.

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

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 can impact the cash flow of the project.

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 Educomp: Shaping Education in the New Millennium

References & Further Readings

Amita Mital, Sanjay Dhir, Sonjoy Mohanty (2018), "Educomp: Shaping Education in the New Millennium Harvard Business Review Case Study. Published by HBR Publications.