The Road to Tortuguero 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 The Road to Tortuguero case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Road to Tortuguero case study is a Harvard Business School (HBR) case study written by Cheri A. Young, Terry G. Nicholas, David L. Corsun, Daryl Loth. The The Road to Tortuguero (referred as “Tortuguero Tga” 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, Financial analysis.

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 The Road to Tortuguero Case Study

The case presents a decision facing a tour guide organization in Tortuguero, Costa Rica regarding environmental sustainability and social equity. Tortuguero was situated on a spit of land, isolated from the rest of the country due to the ocean, rivers, and a protected national park. It was inaccessible by road. Tortuguero was home to the most prolific nesting beach for giant sea turtles in the Atlantic. Turtle-based tourism was the basis of the tiny village's economy. Daryl Loth, President of the Tortuguero Tour Guide Association (TGA), had to oversee a meeting of the TGA, a self-organized group of local tour guides in the village. The TGA had collected a fee of about 40 US cents from each tourist taking a turtle tour and was going to choose one of three proposals for spending its $30K of revenues from the past two years. Community members were permitted to comment at TGA meetings, and some had argued that spending money on a road to Tortuguero would launch an increase in tourists; accessibility to health care, higher education, and lower priced goods and services; and hence, an increase in prosperity and their constitutional right to social equity. Some TGA members believed that an increase in tourists would lead to more business for them and the village businesses, plus greater awareness for the plight of the endangered green sea turtles. Others believed the lack of convenient access to the village was one reason they had been able to protect the turtles and attract new and repeat tourists. This case stimulates discussion of the following questions: What effects would the decision have on the community, the turtles, and the sustainability of ecotourism in Tortuguero in the short and longer term? Should environmental sustainability take precedence over social equity and ready access to medical care, university education, and lower prices for staple goods? What is the ethical choice?

Case Authors : Cheri A. Young, Terry G. Nicholas, David L. Corsun, Daryl Loth

Topic : Leadership & Managing People

Related Areas : Financial analysis

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Calculating Net Present Value (NPV) at 6% for The Road to Tortuguero Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10011913)	-10011913	-	-
Year 1	3445912	-6566001	3445912	0.9434	3250860
Year 2	3953119	-2612882	7399031	0.89	3518262
Year 3	3965678	1352796	11364709	0.8396	3329660
Year 4	3237788	4590584	14602497	0.7921	2564631
TOTAL			14602497		12663413

The Net Present Value at 6% discount rate is 2651500

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

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Formula and Steps to Calculate Net Present Value (NPV) of The Road to Tortuguero

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 Tortuguero Tga 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 Tortuguero Tga 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	(10011913)	-10011913	-	-
Year 1	3445912	-6566001	3445912	0.8696	2996445
Year 2	3953119	-2612882	7399031	0.7561	2989126
Year 3	3965678	1352796	11364709	0.6575	2607498
Year 4	3237788	4590584	14602497	0.5718	1851216
TOTAL					10444285

The Net NPV after 4 years is 432372

(10444285 - 10011913 )

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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	(10011913)	-10011913	-	-
Year 1	3445912	-6566001	3445912	0.8333	2871593
Year 2	3953119	-2612882	7399031	0.6944	2745222
Year 3	3965678	1352796	11364709	0.5787	2294953
Year 4	3237788	4590584	14602497	0.4823	1561433
TOTAL					9473201

The Net NPV after 4 years is -538712

At 20% discount rate the NPV is negative (9473201 - 10011913 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Tortuguero Tga 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 Tortuguero Tga has a NPV value higher than Zero then finance managers at Tortuguero Tga 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 Tortuguero Tga, then the stock price of the Tortuguero Tga 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 Tortuguero Tga 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.

Understanding of risks involved in 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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

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 The Road to Tortuguero

References & Further Readings

Cheri A. Young, Terry G. Nicholas, David L. Corsun, Daryl Loth (2018), "The Road to Tortuguero Harvard Business Review Case Study. Published by HBR Publications.