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Modernization Of Passenger Reservation System: Indian Railways' Dilemma 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 Modernization Of Passenger Reservation System: Indian Railways' Dilemma case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Modernization Of Passenger Reservation System: Indian Railways' Dilemma case study is a Harvard Business School (HBR) case study written by Shirish C. Srivastava, Sharat S. Mathur, Thompson SH Teo. The Modernization Of Passenger Reservation System: Indian Railways' Dilemma (referred as “Prs Ir” 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 Modernization Of Passenger Reservation System: Indian Railways' Dilemma Case Study


This teaching case discusses the challenges being faced by the technology managers at Indian Railways (IR) in the current scenario of a resurgent national economy coupled with increasing customer expectations. In the face of growing competition from road and low-cost airlines, to retain its customers, IR has responded by changing its business rules. The Railway Ministry expects a rapid response from Centre for Railway Information Systems (CRIS) to incorporate all these changes in the passenger reservation system (PRS). The old PRS, which is time-tested and reliable, and has been serving the customers' needs for nearly two decades, is now proving to be relatively inflexible to match the rapidly changing business requirements. Although the current scenario of a constant need to change the programming logic of PRS has been making maintenance tougher for CRIS officials, they have realized that PRS is a time-tested, proven, and reliable technology. Though they would be happy to replace the old PRS with a new state-of-art system that would provide them greater maintenance flexibility, the repercussions associated with possible failure of the new system are far too serious. The case exhibits the current dilemma being faced by the head of CRIS, the umbrella agency for information technology (IT) implementation in IR: whether IR should continue using the old PRS technology with its inherent shortcomings, or should it take the risk and go in for a wholesale replacement with a new state-of-art technology which would provide greater maintenance flexibility?


Case Authors : Shirish C. Srivastava, Sharat S. Mathur, Thompson SH Teo

Topic : Leadership & Managing People

Related Areas :




Calculating Net Present Value (NPV) at 6% for Modernization Of Passenger Reservation System: Indian Railways' Dilemma Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10005227) -10005227 - -
Year 1 3466640 -6538587 3466640 0.9434 3270415
Year 2 3966265 -2572322 7432905 0.89 3529962
Year 3 3971111 1398789 11404016 0.8396 3334221
Year 4 3229575 4628364 14633591 0.7921 2558126
TOTAL 14633591 12692724




The Net Present Value at 6% discount rate is 2687497

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. Net Present Value
2. Internal Rate of Return
3. Profitability Index
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. Timing of the expected cash flows – stockholders of Prs Ir 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. Prs Ir shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of Modernization Of Passenger Reservation System: Indian Railways' Dilemma

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 Prs Ir 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 Prs Ir 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 (10005227) -10005227 - -
Year 1 3466640 -6538587 3466640 0.8696 3014470
Year 2 3966265 -2572322 7432905 0.7561 2999066
Year 3 3971111 1398789 11404016 0.6575 2611070
Year 4 3229575 4628364 14633591 0.5718 1846520
TOTAL 10471126


The Net NPV after 4 years is 465899

(10471126 - 10005227 )








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 (10005227) -10005227 - -
Year 1 3466640 -6538587 3466640 0.8333 2888867
Year 2 3966265 -2572322 7432905 0.6944 2754351
Year 3 3971111 1398789 11404016 0.5787 2298097
Year 4 3229575 4628364 14633591 0.4823 1557473
TOTAL 9498787


The Net NPV after 4 years is -506440

At 20% discount rate the NPV is negative (9498787 - 10005227 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Prs Ir 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 Prs Ir has a NPV value higher than Zero then finance managers at Prs Ir 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 Prs Ir, then the stock price of the Prs Ir 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 Prs Ir 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 –

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.

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.

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.






Negotiation Strategy of Modernization Of Passenger Reservation System: Indian Railways' Dilemma

References & Further Readings

Shirish C. Srivastava, Sharat S. Mathur, Thompson SH Teo (2018), "Modernization Of Passenger Reservation System: Indian Railways' Dilemma Harvard Business Review Case Study. Published by HBR Publications.


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