Chandrabala Modi Academy, Ankleshwar (A) 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 Chandrabala Modi Academy, Ankleshwar (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Chandrabala Modi Academy, Ankleshwar (A) case study is a Harvard Business School (HBR) case study written by Mukund Dixit, Rajeev Sharma. The Chandrabala Modi Academy, Ankleshwar (A) (referred as “School Children” 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 Chandrabala Modi Academy, Ankleshwar (A) Case Study

The case presents the dilemma of Mr. Bhattacharya, the principal of Chandrabala Modi Academy, a three year old co-educational school, having classes up to grade VIII, located in the city of Ankleshwar in the industrial belt of Western India, in responding to a request made by a senior official of the Police Department and President of Rotary Club. He was informed by them that the menace of drug abuse in the city was increasing and how the children of the school might get affected. They had explored the possibility of the school initiating a campaign to educate the local community and the school children, against drugs. Mr. Bhattacharya wondered if the school could organise an activity that engaged the children in swimming across the river Narmada. This could draw the attention of the local community towards the issue. Such an event might also infuse a spirit of adventure among the children and build a positive image for the school. However, crossing the river involved considerable risk as children's lives could be at stake. Police authorities and the Rotary club had offered to support the event. However the consent of the school management, and of the parents whose children would be participating in the river crossing, needed to be taken.

Case Authors : Mukund Dixit, Rajeev Sharma

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Chandrabala Modi Academy, Ankleshwar (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10011206)	-10011206	-	-
Year 1	3451455	-6559751	3451455	0.9434	3256090
Year 2	3957834	-2601917	7409289	0.89	3522458
Year 3	3947047	1345130	11356336	0.8396	3314017
Year 4	3242428	4587558	14598764	0.7921	2568307
TOTAL			14598764		12660871

The Net Present Value at 6% discount rate is 2649665

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. Internal Rate of Return
3. Profitability Index
4. Net Present Value

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. School Children 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 School Children 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 Chandrabala Modi Academy, Ankleshwar (A)

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 School Children 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 School Children 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	(10011206)	-10011206	-	-
Year 1	3451455	-6559751	3451455	0.8696	3001265
Year 2	3957834	-2601917	7409289	0.7561	2992691
Year 3	3947047	1345130	11356336	0.6575	2595247
Year 4	3242428	4587558	14598764	0.5718	1853869
TOTAL					10443073

The Net NPV after 4 years is 431867

(10443073 - 10011206 )

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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	(10011206)	-10011206	-	-
Year 1	3451455	-6559751	3451455	0.8333	2876213
Year 2	3957834	-2601917	7409289	0.6944	2748496
Year 3	3947047	1345130	11356336	0.5787	2284171
Year 4	3242428	4587558	14598764	0.4823	1563671
TOTAL					9472550

The Net NPV after 4 years is -538656

At 20% discount rate the NPV is negative (9472550 - 10011206 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of School Children 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 School Children has a NPV value higher than Zero then finance managers at School Children 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 School Children, then the stock price of the School Children 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 School Children 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.

Understanding of risks involved in 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 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.

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 Chandrabala Modi Academy, Ankleshwar (A)

References & Further Readings

Mukund Dixit, Rajeev Sharma (2018), "Chandrabala Modi Academy, Ankleshwar (A) Harvard Business Review Case Study. Published by HBR Publications.