Era of Quality at the Akshaya Patra Foundation 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 Era of Quality at the Akshaya Patra Foundation case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Era of Quality at the Akshaya Patra Foundation case study is a Harvard Business School (HBR) case study written by Srujana H M, Haritha Saranga, Dinesh Kumar Unnikrishnan. The Era of Quality at the Akshaya Patra Foundation (referred as “Tapf Muralidhar” 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, Product development.

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 Era of Quality at the Akshaya Patra Foundation Case Study

The Akshaya Patra Foundation (TAPF) was founded in 2000 in Bangalore to provide free mid-day meals to the students of government schools. TAPF's kitchen in Vasanthapura provided meals to 650 schools in and around Bangalore benefitting 87,045 children. In 2014, TAPF provided meals to 1.4 million students and by 2020 they wanted to reach out to 5 million students. This massive expansion needs to be achieved without compromising the quality of food provided and simultaneously ensuring that all the key performance indicators such as time of delivery and temperature of food at the time of delivery are maintained as per the specifications. Muralidhar, the head of quality at TAPF along with his team have implemented several quality improvement projects. However, massive expansion plan by TAPF posed a greater challenge to Muralidhar. One of the critical to quality metric in TAPF is the "cooking-to-consumption time'', which should ideally be less than 6 hours. As the number of children to be fed increases, the cooking-to-consumption time is likely to increase. Muralidhar is contemplating use of lean and Six Sigma concepts to ensure that the cooking-to-consumption time is kept within the allowable time limit.

Case Authors : Srujana H M, Haritha Saranga, Dinesh Kumar Unnikrishnan

Topic : Leadership & Managing People

Related Areas : Product development

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Calculating Net Present Value (NPV) at 6% for Era of Quality at the Akshaya Patra Foundation Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10011961)	-10011961	-	-
Year 1	3461262	-6550699	3461262	0.9434	3265342
Year 2	3958875	-2591824	7420137	0.89	3523385
Year 3	3942428	1350604	11362565	0.8396	3310139
Year 4	3233757	4584361	14596322	0.7921	2561438
TOTAL			14596322		12660303

The Net Present Value at 6% discount rate is 2648342

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. Net Present Value
2. Payback Period
3. Profitability Index
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. Tapf Muralidhar 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 Tapf Muralidhar 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 Era of Quality at the Akshaya Patra Foundation

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 Tapf Muralidhar 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 Tapf Muralidhar 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	(10011961)	-10011961	-	-
Year 1	3461262	-6550699	3461262	0.8696	3009793
Year 2	3958875	-2591824	7420137	0.7561	2993478
Year 3	3942428	1350604	11362565	0.6575	2592210
Year 4	3233757	4584361	14596322	0.5718	1848911
TOTAL					10444393

The Net NPV after 4 years is 432432

(10444393 - 10011961 )

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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	(10011961)	-10011961	-	-
Year 1	3461262	-6550699	3461262	0.8333	2884385
Year 2	3958875	-2591824	7420137	0.6944	2749219
Year 3	3942428	1350604	11362565	0.5787	2281498
Year 4	3233757	4584361	14596322	0.4823	1559489
TOTAL					9474591

The Net NPV after 4 years is -537370

At 20% discount rate the NPV is negative (9474591 - 10011961 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Tapf Muralidhar 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 Tapf Muralidhar has a NPV value higher than Zero then finance managers at Tapf Muralidhar 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 Tapf Muralidhar, then the stock price of the Tapf Muralidhar 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 Tapf Muralidhar 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 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.

Understanding of risks involved in the project.

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 Era of Quality at the Akshaya Patra Foundation

References & Further Readings

Srujana H M, Haritha Saranga, Dinesh Kumar Unnikrishnan (2018), "Era of Quality at the Akshaya Patra Foundation Harvard Business Review Case Study. Published by HBR Publications.