"LARSENS CAMP: CRISIS IN KENYA'S ELEPHANT PARADISE 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 "LARSENS CAMP: CRISIS IN KENYA'S ELEPHANT PARADISE case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. "LARSENS CAMP: CRISIS IN KENYA'S ELEPHANT PARADISE case study is a Harvard Business School (HBR) case study written by Benoit Leleux, Aoife Hegarty. The "LARSENS CAMP: CRISIS IN KENYA'S ELEPHANT PARADISE (referred as “Larsens Rohan” 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, Talent management.

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 "LARSENS CAMP: CRISIS IN KENYA'S ELEPHANT PARADISE Case Study

Rohan Patel was looking at the building site outside the window of his third-floor office in Westlands, the upmarket business district of Nairobi, Kenya. Although the construction work would be finished in a few weeks' time, it had taken a total of 18 months to complete and was seriously behind schedule. In early 2009, time was definitely money for Rohan's family firm, Grenadier Limited. The building was to be the first of a chain of contemporary five star hotels catering to the needs of business travelers in urban centers in Africa.The chain would be the latest addition to Grenadier's portfolio. Rohan hoped it would not be plagued by the occupancy problems that Larsens Camp was experiencing - one of the three properties that made up Wilderness Lodges, the company's other luxury hospitality business. The tourist trade in Kenya had been hit by the double whammy of political violence followed by the credit crunch and global recession, both of which had been nothing short of disastrous for the hospitality business. The tourism crisis, in turn, led to a renewal of public debate around the sustainable management of Kenya's natural resources. Some operators saw an opportunity to push for a relaxation of existing rules for establishing hotels and resorts in and around nature reserves, which would create new jobs and increase tax revenues for the state and local councils. However, nature preservationists and environmental NGOs wanted to protect the animal sanctuaries and the local communities that often lost their ancestors' lands to the nature reserves without getting much in return. In addition to getting the new venture off the ground and taking the risk of stepping on the toes of established players, Rohan needed to tackle these other challenges: How could the group rebuild a value proposition for tourists and restore occupancy rates at Larsens Camp? What was the best way to restructure the company to ensure financial stability? How could it find the proper balance between its business and the environment, thus ensuring the future of its resorts? Learning objectives: The case discusses various issues including social responsibility in the context of a hospitality business in Kenya's Samburu Nature Reserve; the heritage of the Indian diaspora in East Africa and its business activities and modus operandi; the transition of a third-generation family member who returns from Europe to join the family business; and sustainability management of the family's sprawling business empire. The case also provides an original setting for the discussion of stakeholder management (the bush).

Case Authors : Benoit Leleux, Aoife Hegarty

Topic : Leadership & Managing People

Related Areas : Talent management

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Calculating Net Present Value (NPV) at 6% for "LARSENS CAMP: CRISIS IN KENYA'S ELEPHANT PARADISE Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10008535)	-10008535	-	-
Year 1	3458111	-6550424	3458111	0.9434	3262369
Year 2	3969606	-2580818	7427717	0.89	3532935
Year 3	3940180	1359362	11367897	0.8396	3308251
Year 4	3232634	4591996	14600531	0.7921	2560549
TOTAL			14600531		12664104

The Net Present Value at 6% discount rate is 2655569

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. Internal Rate of Return
4. Profitability Index

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. Larsens Rohan 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 Larsens Rohan 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 "LARSENS CAMP: CRISIS IN KENYA'S ELEPHANT PARADISE

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 Larsens Rohan 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 Larsens Rohan 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	(10008535)	-10008535	-	-
Year 1	3458111	-6550424	3458111	0.8696	3007053
Year 2	3969606	-2580818	7427717	0.7561	3001592
Year 3	3940180	1359362	11367897	0.6575	2590732
Year 4	3232634	4591996	14600531	0.5718	1848269
TOTAL					10447647

The Net NPV after 4 years is 439112

(10447647 - 10008535 )

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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	(10008535)	-10008535	-	-
Year 1	3458111	-6550424	3458111	0.8333	2881759
Year 2	3969606	-2580818	7427717	0.6944	2756671
Year 3	3940180	1359362	11367897	0.5787	2280197
Year 4	3232634	4591996	14600531	0.4823	1558948
TOTAL					9477574

The Net NPV after 4 years is -530961

At 20% discount rate the NPV is negative (9477574 - 10008535 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Larsens Rohan 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 Larsens Rohan has a NPV value higher than Zero then finance managers at Larsens Rohan 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 Larsens Rohan, then the stock price of the Larsens Rohan 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 Larsens Rohan 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 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.

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.

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 "LARSENS CAMP: CRISIS IN KENYA'S ELEPHANT PARADISE

References & Further Readings

Benoit Leleux, Aoife Hegarty (2018), ""LARSENS CAMP: CRISIS IN KENYA'S ELEPHANT PARADISE Harvard Business Review Case Study. Published by HBR Publications.