Kudremukh Iron Ore Company Ltd: The Sun Sets on Its Mining Operations 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 Kudremukh Iron Ore Company Ltd: The Sun Sets on Its Mining Operations case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Kudremukh Iron Ore Company Ltd: The Sun Sets on Its Mining Operations case study is a Harvard Business School (HBR) case study written by K. N. Murthy, D.V.R. Seshadri. The Kudremukh Iron Ore Company Ltd: The Sun Sets on Its Mining Operations (referred as “Kudremukh Kiocl” 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, International business, Social responsibility, Sustainability.

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 Kudremukh Iron Ore Company Ltd: The Sun Sets on Its Mining Operations Case Study

Kudremukh is a breathtaking mountain range in Chickamagalur District, Karnataka, India. Three rivers originate here and form an important lifeline for South India; the is ecologically very sensitive. The National Mineral Development Corporation (NMDC) conducted prospecting surveys in 1967 and obtained a mining license from the government of Karnataka for an area of 5218 hectares. In 1969, the government of India floated a public-sector undertaking, the Kudremukh Iron Ore Company (KIOCL), and NMDC turned over its 30-year mining lease to KIOCL. The majority of the surrounding communities were apprehensive about the possible impacts of massive mining operations in the virgin forest area. KIOCL's mining activities flourished, making it into Asia's largest mining and pelletization company. However, in 1985, the government of Karnataka declared Kudremukh region as a National Park under the Wildlife (Protection) Act of 1972, in order to provide effective protection to the rich flora and fauna in the region. The area leased to KIOCL was an enclave within the southern half of the national park and the mining operations started witnessing opposition in 1995, with wildlife conservationists and environment protection organizations staging rallies and agitations against KIOCL's operations. Activists filed numerous petitions in the Supreme Court, asking the court to end the activities of KIOCL in order to protect Kudremukh from the ravages of mining. The case focuses on important issues relating to shareholder vs. stakeholder responsibility in the context of ongoing ecological degradation, increased environmental awareness in Indian society, and consequent changes in legislation.

Case Authors : K. N. Murthy, D.V.R. Seshadri

Topic : Leadership & Managing People

Related Areas : International business, Social responsibility, Sustainability

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Calculating Net Present Value (NPV) at 6% for Kudremukh Iron Ore Company Ltd: The Sun Sets on Its Mining Operations Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019809)	-10019809	-	-
Year 1	3452501	-6567308	3452501	0.9434	3257076
Year 2	3956458	-2610850	7408959	0.89	3521234
Year 3	3952619	1341769	11361578	0.8396	3318695
Year 4	3235668	4577437	14597246	0.7921	2562952
TOTAL			14597246		12659957

The Net Present Value at 6% discount rate is 2640148

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. 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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Kudremukh Kiocl 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 Kudremukh Kiocl 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 Kudremukh Iron Ore Company Ltd: The Sun Sets on Its Mining Operations

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 Kudremukh Kiocl 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 Kudremukh Kiocl 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	(10019809)	-10019809	-	-
Year 1	3452501	-6567308	3452501	0.8696	3002175
Year 2	3956458	-2610850	7408959	0.7561	2991651
Year 3	3952619	1341769	11361578	0.6575	2598911
Year 4	3235668	4577437	14597246	0.5718	1850004
TOTAL					10442740

The Net NPV after 4 years is 422931

(10442740 - 10019809 )

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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	(10019809)	-10019809	-	-
Year 1	3452501	-6567308	3452501	0.8333	2877084
Year 2	3956458	-2610850	7408959	0.6944	2747540
Year 3	3952619	1341769	11361578	0.5787	2287395
Year 4	3235668	4577437	14597246	0.4823	1560411
TOTAL					9472431

The Net NPV after 4 years is -547378

At 20% discount rate the NPV is negative (9472431 - 10019809 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Kudremukh Kiocl 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 Kudremukh Kiocl has a NPV value higher than Zero then finance managers at Kudremukh Kiocl 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 Kudremukh Kiocl, then the stock price of the Kudremukh Kiocl 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 Kudremukh Kiocl 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 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.

Understanding of risks involved in 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 Kudremukh Iron Ore Company Ltd: The Sun Sets on Its Mining Operations

References & Further Readings

K. N. Murthy, D.V.R. Seshadri (2018), "Kudremukh Iron Ore Company Ltd: The Sun Sets on Its Mining Operations Harvard Business Review Case Study. Published by HBR Publications.