Carvajal, S.A.: Building on a Century of Business Growth and Family Values 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 Carvajal, S.A.: Building on a Century of Business Growth and Family Values case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Carvajal, S.A.: Building on a Century of Business Growth and Family Values case study is a Harvard Business School (HBR) case study written by Ivan Lansberg, Mary Alice Crump, Sachin Waikar. The Carvajal, S.A.: Building on a Century of Business Growth and Family Values (referred as “Family Carvajal” 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, Communication, Growth strategy, Leadership, Organizational culture, Organizational structure, Social responsibility.

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 Carvajal, S.A.: Building on a Century of Business Growth and Family Values Case Study

This case presents the history and recent governance challenges of Carvajal, S.A., a Colombia-based, family-owned, billion-dollar-plus holding company that had offered printing-related (e.g., Yellow Pages, notebooks) and other products and services across and beyond South America for more than a century. Specifically, the case details the company's state of affairs in early 2011, a time by which Carvajal's flagship businesses had matured rapidly with the emergence of digital technology and diminished demand for paper/print-based products. Though profits and growth remained positive, Carvajal's leaders knew that upholding the business's legacy of returns, dividends for all family members, and extensive philanthropy would take significant strategy and execution. Compounding the strategy issues, Carvajal faced these market challenges with new leadership: the first non-family CEO since the company's inception. Well-established Colombian executive Ricardo Obregon had been hired in 2008 over two family candidates to lead the business. Obregon was to oversee a complex governance network that included a holding company with seven operating companies, their management and respective boards, a family council, and 280 members (including spouses) of a shareholding family in its sixth generation. Carvajal's business and family leaders had to face market issues and decisions that included the possibility of taking public the operating companies and/or the holding company while maintaining the business's long traditions of unity, respect, strong ethics, and philanthropy. That meant optimizing several crucial relationships: between the family and the new CEO; between the family and the board; between the operating companies and the holding company; and between members of the large Carvajal family, many of whom now resided outside of Colombia and Latin America.

Case Authors : Ivan Lansberg, Mary Alice Crump, Sachin Waikar

Topic : Leadership & Managing People

Related Areas : Communication, Growth strategy, Leadership, Organizational culture, Organizational structure, Social responsibility

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Calculating Net Present Value (NPV) at 6% for Carvajal, S.A.: Building on a Century of Business Growth and Family Values Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10000169)	-10000169	-	-
Year 1	3467107	-6533062	3467107	0.9434	3270856
Year 2	3959974	-2573088	7427081	0.89	3524363
Year 3	3961977	1388889	11389058	0.8396	3326552
Year 4	3238123	4627012	14627181	0.7921	2564897
TOTAL			14627181		12686667

The Net Present Value at 6% discount rate is 2686498

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. Profitability Index
3. Net Present Value
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Family Carvajal 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 Family Carvajal 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 Carvajal, S.A.: Building on a Century of Business Growth and Family Values

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 Family Carvajal 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 Family Carvajal 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	(10000169)	-10000169	-	-
Year 1	3467107	-6533062	3467107	0.8696	3014876
Year 2	3959974	-2573088	7427081	0.7561	2994309
Year 3	3961977	1388889	11389058	0.6575	2605064
Year 4	3238123	4627012	14627181	0.5718	1851407
TOTAL					10465656

The Net NPV after 4 years is 465487

(10465656 - 10000169 )

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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	(10000169)	-10000169	-	-
Year 1	3467107	-6533062	3467107	0.8333	2889256
Year 2	3959974	-2573088	7427081	0.6944	2749982
Year 3	3961977	1388889	11389058	0.5787	2292811
Year 4	3238123	4627012	14627181	0.4823	1561595
TOTAL					9493643

The Net NPV after 4 years is -506526

At 20% discount rate the NPV is negative (9493643 - 10000169 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Family Carvajal 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 Family Carvajal has a NPV value higher than Zero then finance managers at Family Carvajal 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 Family Carvajal, then the stock price of the Family Carvajal 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 Family Carvajal 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 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.

Understanding of risks involved in 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.

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

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 Carvajal, S.A.: Building on a Century of Business Growth and Family Values

References & Further Readings

Ivan Lansberg, Mary Alice Crump, Sachin Waikar (2018), "Carvajal, S.A.: Building on a Century of Business Growth and Family Values Harvard Business Review Case Study. Published by HBR Publications.