Lan-Ray Global Payment Services 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 Lan-Ray Global Payment Services case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Lan-Ray Global Payment Services case study is a Harvard Business School (HBR) case study written by Wee Yong Yeo. The Lan-Ray Global Payment Services (referred as “Pcn Lan” 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, Financial management, International business, Leadership, Organizational culture, Strategy.

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 Lan-Ray Global Payment Services Case Study

Lan-Ray in Singapore attempted to break into the prepaid cash card (PCC) business in China. Equity funds were sourced to acquire Protection Communications Network (PCN), a payment intermediary in Quanzhou, China, with a vast payment network, which could be instrumental to the success of the PCC business. However, PCN would need to demonstrate profitability before they could obtain the licence to run the PCC business. Together, Lan-Ray and PCN ventured into the mobile phone campus e-card business, which was initially assessed to be able to help PCN achieve profitability in the short run. However, the campus e-card business did not prove to be as profitable as expected. At the same time, the acquisition of PCN by Lan-Ray hit a road block as PCN was unwilling to transfer shares to Lan-Ray.

Case Authors : Wee Yong Yeo

Topic : Leadership & Managing People

Related Areas : Financial management, International business, Leadership, Organizational culture, Strategy

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Calculating Net Present Value (NPV) at 6% for Lan-Ray Global Payment Services Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018540)	-10018540	-	-
Year 1	3457200	-6561340	3457200	0.9434	3261509
Year 2	3976014	-2585326	7433214	0.89	3538638
Year 3	3944050	1358724	11377264	0.8396	3311500
Year 4	3235189	4593913	14612453	0.7921	2562573
TOTAL			14612453		12674221

The Net Present Value at 6% discount rate is 2655681

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. Timing of the expected cash flows – stockholders of Pcn Lan 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. Pcn Lan 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 Lan-Ray Global Payment Services

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 Pcn Lan 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 Pcn Lan 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	(10018540)	-10018540	-	-
Year 1	3457200	-6561340	3457200	0.8696	3006261
Year 2	3976014	-2585326	7433214	0.7561	3006438
Year 3	3944050	1358724	11377264	0.6575	2593277
Year 4	3235189	4593913	14612453	0.5718	1849730
TOTAL					10455705

The Net NPV after 4 years is 437165

(10455705 - 10018540 )

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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	(10018540)	-10018540	-	-
Year 1	3457200	-6561340	3457200	0.8333	2881000
Year 2	3976014	-2585326	7433214	0.6944	2761121
Year 3	3944050	1358724	11377264	0.5787	2282436
Year 4	3235189	4593913	14612453	0.4823	1560180
TOTAL					9484737

The Net NPV after 4 years is -533803

At 20% discount rate the NPV is negative (9484737 - 10018540 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Pcn Lan 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 Pcn Lan has a NPV value higher than Zero then finance managers at Pcn Lan 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 Pcn Lan, then the stock price of the Pcn Lan 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 Pcn Lan 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.

Understanding of risks involved in the project.

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.

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 Lan-Ray Global Payment Services

References & Further Readings

Wee Yong Yeo (2018), "Lan-Ray Global Payment Services Harvard Business Review Case Study. Published by HBR Publications.