CEMEX Mexico: The Path to Responsible Competitiveness 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 CEMEX Mexico: The Path to Responsible Competitiveness case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. CEMEX Mexico: The Path to Responsible Competitiveness case study is a Harvard Business School (HBR) case study written by Loretta Serrano, Hector Diaz-Saenz. The CEMEX Mexico: The Path to Responsible Competitiveness (referred as “Sr Cemex” 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 CEMEX Mexico: The Path to Responsible Competitiveness Case Study

The case presents CEMEX Mexico's situation in 2004, shortly after its social responsibility committee was created and became operational. Two distinctive stages in SR development are described. During the first stage, the company's SR approach was paternalistic and lacking in strategic meaning. The second stage started as a result of several organizational changes undertaken to streamline SR efforts and to incorporate them into the company's business strategy. This shift was initiated in the late 1990s, when CEMEX reviewed its contingency management processes and fueled the creation of its Social Responsibility Unit, the coordination of community relations and the establishment of its Communications and Social Responsibility Committees. Although social responsibility initiatives had begun to bear fruit, the company faced the challenge of integrating it into its culture. SR was a strategy known mainly to top management, but it was not explicitly embedded in training, recruiting, compensation or performance evaluation practices. This hindered its swift incorporation into the company's organizational culture. The case describes the organizational change process (in terms of strategy, structure and culture) that resulted from SR adoption and the managerial decisions geared at its internalization. There was little evidence to assess how deep this cultural change really was. A personnel survey had revealed that most employees were unaware of CEMEX's community-oriented initiatives. The SR Manager's goal was to turn this issue into a personal trait for both the company and its employees -i.e., to embed it in CEMEX Mexico's DNA. Yet, some members in the organization were still doubtful.

Case Authors : Loretta Serrano, Hector Diaz-Saenz

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for CEMEX Mexico: The Path to Responsible Competitiveness Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10002229)	-10002229	-	-
Year 1	3467638	-6534591	3467638	0.9434	3271357
Year 2	3980501	-2554090	7448139	0.89	3542632
Year 3	3936330	1382240	11384469	0.8396	3305019
Year 4	3243780	4626020	14628249	0.7921	2569378
TOTAL			14628249		12688384

The Net Present Value at 6% discount rate is 2686155

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

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 Sr Cemex 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. Sr Cemex shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of CEMEX Mexico: The Path to Responsible Competitiveness

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 Sr Cemex 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 Sr Cemex 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	(10002229)	-10002229	-	-
Year 1	3467638	-6534591	3467638	0.8696	3015337
Year 2	3980501	-2554090	7448139	0.7561	3009831
Year 3	3936330	1382240	11384469	0.6575	2588201
Year 4	3243780	4626020	14628249	0.5718	1854642
TOTAL					10468011

The Net NPV after 4 years is 465782

(10468011 - 10002229 )

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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	(10002229)	-10002229	-	-
Year 1	3467638	-6534591	3467638	0.8333	2889698
Year 2	3980501	-2554090	7448139	0.6944	2764237
Year 3	3936330	1382240	11384469	0.5787	2277969
Year 4	3243780	4626020	14628249	0.4823	1564323
TOTAL					9496227

The Net NPV after 4 years is -506002

At 20% discount rate the NPV is negative (9496227 - 10002229 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Sr Cemex 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 Sr Cemex has a NPV value higher than Zero then finance managers at Sr Cemex 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 Sr Cemex, then the stock price of the Sr Cemex 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 Sr Cemex 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 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.

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

What can impact the cash flow of the project.

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 CEMEX Mexico: The Path to Responsible Competitiveness

References & Further Readings

Loretta Serrano, Hector Diaz-Saenz (2018), "CEMEX Mexico: The Path to Responsible Competitiveness Harvard Business Review Case Study. Published by HBR Publications.