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Olivia Lum: Wanting to Save the World 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 Olivia Lum: Wanting to Save the World case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Olivia Lum: Wanting to Save the World case study is a Harvard Business School (HBR) case study written by Geoffrey G. Jones, Essie Alamsyah. The Olivia Lum: Wanting to Save the World (referred as “Lum Hyflux” 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, Competition, Entrepreneurship, Globalization, Operations management, Sustainability.

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 Olivia Lum: Wanting to Save the World Case Study


This case considers the entrepreneurial career of Olivia Lum, who founded the Singaporean water company Hyflux in 1989. An orphan born in Malaysia, Lum provides a rare case of an entrepreneurial success in a country whose economic success has primarily rested on state-owned and foreign firms. The case describes the formidable challenges she initially faced, her subsequent breakthrough in China, and the subsequent growth as a global water treatment company employing membrane technology. In 2004 the company entered the large Middle Eastern market for water treatment but soon encountered problems, including political turbulence. The case ends with demonstrations and an emergent crisis in Libya in 2011, a country in which Hyflux had recently invested. The case offers opportunities to explore the nature of entrepreneurship in Southeast Asia, the business importance of relationships between overseas Chinese and mainland China, and the challenges faced by female entrepreneurs. More broadly, it serves as vehicle for teaching students about the global water crisis and the role of business in helping to resolve it.


Case Authors : Geoffrey G. Jones, Essie Alamsyah

Topic : Leadership & Managing People

Related Areas : Competition, Entrepreneurship, Globalization, Operations management, Sustainability




Calculating Net Present Value (NPV) at 6% for Olivia Lum: Wanting to Save the World Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10019299) -10019299 - -
Year 1 3443795 -6575504 3443795 0.9434 3248863
Year 2 3969596 -2605908 7413391 0.89 3532926
Year 3 3954091 1348183 11367482 0.8396 3319931
Year 4 3246687 4594870 14614169 0.7921 2571680
TOTAL 14614169 12673401


The Net Present Value at 6% discount rate is 2654102

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

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. Lum Hyflux 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 Lum Hyflux have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.




Formula and Steps to Calculate Net Present Value (NPV) of Olivia Lum: Wanting to Save the World

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 Lum Hyflux 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 Lum Hyflux 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 (10019299) -10019299 - -
Year 1 3443795 -6575504 3443795 0.8696 2994604
Year 2 3969596 -2605908 7413391 0.7561 3001585
Year 3 3954091 1348183 11367482 0.6575 2599879
Year 4 3246687 4594870 14614169 0.5718 1856304
TOTAL 10452372


The Net NPV after 4 years is 433073

(10452372 - 10019299 )






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 (10019299) -10019299 - -
Year 1 3443795 -6575504 3443795 0.8333 2869829
Year 2 3969596 -2605908 7413391 0.6944 2756664
Year 3 3954091 1348183 11367482 0.5787 2288247
Year 4 3246687 4594870 14614169 0.4823 1565725
TOTAL 9480465


The Net NPV after 4 years is -538834

At 20% discount rate the NPV is negative (9480465 - 10019299 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Lum Hyflux 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 Lum Hyflux has a NPV value higher than Zero then finance managers at Lum Hyflux 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 Lum Hyflux, then the stock price of the Lum Hyflux 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 Lum Hyflux 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.

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.

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.

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.




References & Further Readings

Geoffrey G. Jones, Essie Alamsyah (2018), "Olivia Lum: Wanting to Save the World Harvard Business Review Case Study. Published by HBR Publications.