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DR. REDDY'S: MEDICINE IS FOR PEOPLE, PROFITS FOLLOW 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 DR. REDDY'S: MEDICINE IS FOR PEOPLE, PROFITS FOLLOW case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. DR. REDDY'S: MEDICINE IS FOR PEOPLE, PROFITS FOLLOW case study is a Harvard Business School (HBR) case study written by Bala Chakravarthy, Sophie Coughlan. The DR. REDDY'S: MEDICINE IS FOR PEOPLE, PROFITS FOLLOW (referred as “Rhp Pill” 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




Case Description of DR. REDDY'S: MEDICINE IS FOR PEOPLE, PROFITS FOLLOW Case Study


This case describes the launching of a polypill at Dr. Reddy's to help patients with a high risk of Cardio Vascular Disease (CVD) prevent a second heart attack or stroke. Called the Red Heart Pill (RHP), this combination pill included four therapeutic agents: One to lower cholesterol, the other two to lower blood pressure and a fourth, Aspirin, to thin out the blood.Taken together they were estimated to lower the risk of a second heart attack or stroke by 55%.The RHP was particularly attractive to treat the poor. At a treatment cost of just US$ 25 a year, the RHP was expected to make a major dent in lowering CVD-related deaths and disabilities in India. Dr. Reddy's had completed clinical trials to launch the pill in India and international clinical trials were under way to launch the pill in other markets. The company also hoped to introduce a variant of the pill for primary prevention, helping patients with a low to moderate risk of CVD avert a first heart attack or stroke. The case details the many dilemmas that the top management team of Dr. Reddy's faced in pursuing the RHP project. The active ingredients in the RHP were generic drugs; and yet, because the combination had never been offered before, the RHP had to go through clinical trials to prove its bioequivalence to each of the constituent drugs. The RHP also had to be marketed to physicians and could be sold only through a prescription. The added R&D and marketing costs had to be recouped through the price of the RHP, although this price had to be closer to generics prices. In addition, it would be hard to get a patent for the RHP. Here was a pill that was neither a new discovery drug nor a straight generic. Shaping a strategy for it was demanding and yet if the RHP could be launched successfully, there would be several other opportunities for a combination pill to treat other chronic diseases like depression and osteoarthritis. Learning objectives: The case is a good vehicle to discuss the changing landscape of the global pharmaceutical industry which is faced with the simultaneous challenge of a thinning new product pipeline and increasing pressures from government regulators and third party payers to cut costs. Projects like the RHP at Dr. Reddy's provide examples of the new business models (and the dilemmas that underlie them) that industry leaders would have to consider. Projects like the RHP at Dr. Reddy's provide examples of the new business models (and the dilemmas that underlie them) that industry leaders would have to consider. The case also provides an excellent background from which to profile effective social entrepreneurs, such as the executive in charge of the RHP, Raghu Cidambi.


Case Authors : Bala Chakravarthy, Sophie Coughlan

Topic : Leadership & Managing People

Related Areas :




Calculating Net Present Value (NPV) at 6% for DR. REDDY'S: MEDICINE IS FOR PEOPLE, PROFITS FOLLOW Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10019911) -10019911 - -
Year 1 3461970 -6557941 3461970 0.9434 3266009
Year 2 3972929 -2585012 7434899 0.89 3535893
Year 3 3948926 1363914 11383825 0.8396 3315594
Year 4 3246645 4610559 14630470 0.7921 2571647
TOTAL 14630470 12689143


The Net Present Value at 6% discount rate is 2669232

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.




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. Rhp Pill 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 Rhp Pill have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.




Formula and Steps to Calculate Net Present Value (NPV) of DR. REDDY'S: MEDICINE IS FOR PEOPLE, PROFITS FOLLOW

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 Rhp Pill 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 Rhp Pill 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 (10019911) -10019911 - -
Year 1 3461970 -6557941 3461970 0.8696 3010409
Year 2 3972929 -2585012 7434899 0.7561 3004105
Year 3 3948926 1363914 11383825 0.6575 2596483
Year 4 3246645 4610559 14630470 0.5718 1856280
TOTAL 10467277


The Net NPV after 4 years is 447366

(10467277 - 10019911 )






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 (10019911) -10019911 - -
Year 1 3461970 -6557941 3461970 0.8333 2884975
Year 2 3972929 -2585012 7434899 0.6944 2758978
Year 3 3948926 1363914 11383825 0.5787 2285258
Year 4 3246645 4610559 14630470 0.4823 1565705
TOTAL 9494916


The Net NPV after 4 years is -524995

At 20% discount rate the NPV is negative (9494916 - 10019911 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Rhp Pill 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 Rhp Pill has a NPV value higher than Zero then finance managers at Rhp Pill 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 Rhp Pill, then the stock price of the Rhp Pill 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 Rhp Pill 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.




References & Further Readings

Bala Chakravarthy, Sophie Coughlan (2018), "DR. REDDY'S: MEDICINE IS FOR PEOPLE, PROFITS FOLLOW Harvard Business Review Case Study. Published by HBR Publications.