Chartered Speed and the Bus Rapid Transit System 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 Chartered Speed and the Bus Rapid Transit System case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Chartered Speed and the Bus Rapid Transit System case study is a Harvard Business School (HBR) case study written by Debjit Roy, John Joy, Vaibhav Malhotra. The Chartered Speed and the Bus Rapid Transit System (referred as “Ahmedabad Buses” 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, Time 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 Chartered Speed and the Bus Rapid Transit System Case Study

In June 2014, Chartered Speed Private Limited, the contract provider for the much acclaimed Bus Rapid Transit System of Ahmedabad, India, would like to improve customer service in order to position itself strongly during upcoming contract renewal talks with Ahmedabad Janmarg Limited, the municipal body responsible for the system. Buses arrive at the company's workshops during the night for daily repairs and leave the next morning for their scheduled runs. However, given time and resource constraints, bus departures may either be delayed or buses may have to leave the workshop without the scheduled repair operations. Moreover, there is a long list of deficiencies with the buses or drivers and of incidents, such as accidents or breakdowns, that can result in financial penalties to the company. How should maintenance activities be designed to minimize the penalty losses and guarantee high customer service levels? Authors are affiliated with Indian Institute of Management Ahmedabad.

Case Authors : Debjit Roy, John Joy, Vaibhav Malhotra

Topic : Leadership & Managing People

Related Areas : Time management

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Calculating Net Present Value (NPV) at 6% for Chartered Speed and the Bus Rapid Transit System Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018387)	-10018387	-	-
Year 1	3443259	-6575128	3443259	0.9434	3248358
Year 2	3955088	-2620040	7398347	0.89	3520014
Year 3	3970382	1350342	11368729	0.8396	3333609
Year 4	3226573	4576915	14595302	0.7921	2555748
TOTAL			14595302		12657729

The Net Present Value at 6% discount rate is 2639342

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. Payback Period
2. Net Present Value
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. Ahmedabad Buses 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 Ahmedabad Buses 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 Chartered Speed and the Bus Rapid Transit System

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 Ahmedabad Buses 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 Ahmedabad Buses 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	(10018387)	-10018387	-	-
Year 1	3443259	-6575128	3443259	0.8696	2994138
Year 2	3955088	-2620040	7398347	0.7561	2990615
Year 3	3970382	1350342	11368729	0.6575	2610591
Year 4	3226573	4576915	14595302	0.5718	1844804
TOTAL					10440147

The Net NPV after 4 years is 421760

(10440147 - 10018387 )

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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	(10018387)	-10018387	-	-
Year 1	3443259	-6575128	3443259	0.8333	2869383
Year 2	3955088	-2620040	7398347	0.6944	2746589
Year 3	3970382	1350342	11368729	0.5787	2297675
Year 4	3226573	4576915	14595302	0.4823	1556025
TOTAL					9469671

The Net NPV after 4 years is -548716

At 20% discount rate the NPV is negative (9469671 - 10018387 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ahmedabad Buses 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 Ahmedabad Buses has a NPV value higher than Zero then finance managers at Ahmedabad Buses 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 Ahmedabad Buses, then the stock price of the Ahmedabad Buses 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 Ahmedabad Buses 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 key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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

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 Chartered Speed and the Bus Rapid Transit System

References & Further Readings

Debjit Roy, John Joy, Vaibhav Malhotra (2018), "Chartered Speed and the Bus Rapid Transit System Harvard Business Review Case Study. Published by HBR Publications.