Volkswagen Navarra, 8th Collective Agreement (B) 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 Volkswagen Navarra, 8th Collective Agreement (B) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Volkswagen Navarra, 8th Collective Agreement (B) case study is a Harvard Business School (HBR) case study written by Guido Stein Martinez, Carlos Escobar, Marta Cuadrado, Jose Ramon Pin Arboledas. The Volkswagen Navarra, 8th Collective Agreement (B) (referred as “Navarra Agreement” 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

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Case Description of Volkswagen Navarra, 8th Collective Agreement (B) Case Study

Supplement case for IES332.After more than eight months without the negotiating parties managing to reach an agreement, the unions decided to call in their German counterpart to help find a solution and make the parent company aware of why it had not been possible to reach an agreement in Spain. On the other hand, in response to the drawn out nature of the negotiating period, the management from Wolfsburg contacted Patrick and Carlos to find out what was causing the lack of agreement that had continued for several months at the plant in Navarra. Carlos argued that it stemmed from the union representatives' continuous rejection of the proposals put together by his team, who could not manage to gain approval for any of their proposals.The head of human resources for the Volkswagen brand, Martin Rosick, and the representative of IG Metall and general secretary of the VW European and Global Workers' Committee, Frank Patta, were given the job of visiting Navarra on July 23 and 24 to respond to the call from the union representatives and to help resolve the deadlock in the process of negotiating the agreement by facilitating dialogue between the parties. On the afternoon of July 23, all of the union representatives from the plant met with Frank Patta to discuss the demands that the platform had proposed as well as the barriers that had been put up by the management of the company up to that point.

Case Authors : Guido Stein Martinez, Carlos Escobar, Marta Cuadrado, Jose Ramon Pin Arboledas

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Volkswagen Navarra, 8th Collective Agreement (B) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10009131)	-10009131	-	-
Year 1	3444264	-6564867	3444264	0.9434	3249306
Year 2	3981023	-2583844	7425287	0.89	3543096
Year 3	3936485	1352641	11361772	0.8396	3305149
Year 4	3250593	4603234	14612365	0.7921	2574774
TOTAL			14612365		12672325

The Net Present Value at 6% discount rate is 2663194

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. Profitability Index
3. Internal Rate of Return
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. Navarra Agreement 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 Navarra Agreement 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 Volkswagen Navarra, 8th Collective Agreement (B)

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 Navarra Agreement 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 Navarra Agreement 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	(10009131)	-10009131	-	-
Year 1	3444264	-6564867	3444264	0.8696	2995012
Year 2	3981023	-2583844	7425287	0.7561	3010225
Year 3	3936485	1352641	11361772	0.6575	2588303
Year 4	3250593	4603234	14612365	0.5718	1858537
TOTAL					10452077

The Net NPV after 4 years is 442946

(10452077 - 10009131 )

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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	(10009131)	-10009131	-	-
Year 1	3444264	-6564867	3444264	0.8333	2870220
Year 2	3981023	-2583844	7425287	0.6944	2764599
Year 3	3936485	1352641	11361772	0.5787	2278058
Year 4	3250593	4603234	14612365	0.4823	1567609
TOTAL					9480486

The Net NPV after 4 years is -528645

At 20% discount rate the NPV is negative (9480486 - 10009131 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Navarra Agreement 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 Navarra Agreement has a NPV value higher than Zero then finance managers at Navarra Agreement 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 Navarra Agreement, then the stock price of the Navarra Agreement 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 Navarra Agreement 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.

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 Volkswagen Navarra, 8th Collective Agreement (B)

References & Further Readings

Guido Stein Martinez, Carlos Escobar, Marta Cuadrado, Jose Ramon Pin Arboledas (2018), "Volkswagen Navarra, 8th Collective Agreement (B) Harvard Business Review Case Study. Published by HBR Publications.