AIACA: Interventions for Sustainable Livelihoods 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 AIACA: Interventions for Sustainable Livelihoods case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. AIACA: Interventions for Sustainable Livelihoods case study is a Harvard Business School (HBR) case study written by Sonu Goyal. The AIACA: Interventions for Sustainable Livelihoods (referred as “Aiaca Craftworkers” 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, International business.

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 AIACA: Interventions for Sustainable Livelihoods Case Study

In 2003, the All India Artisans and Craftworkers Welfare Association (AIACA) was launched to explore new and commercially sustainable models of livelihood promotion for India's vulnerable communities of craftworkers. The Indian handlooms and handicrafts, collectively referred to as the craft sector, symbolized the rich historical and cultural diversity that distinguished India from the rest of the world. The sector provided low-cost, "green" livelihood opportunities to millions of Indian families, supplementing their incomes in seasons of agrarian distress, checking migration, and preserving traditional economic relationships. The sector represented the economic lifeline of the most vulnerable sections of Indian society. AIACA took a unique approach towards stakeholder engagement by establishing partnerships with local non-governmental organizations, business enterprises, individual craftworkers, self-help groups, and government agencies. This level of co-operation produced effective advocacy and high-impact developmental work through multiplicative strategies, and the results were scalable and replicable in the context of informal sectors in transitioning economies. AIACA had spent a decade successfully designing and implementing livelihood interventions to help small-scale, family-managed businesses evolve into sustainable enterprises and innovative networks. The organization now needed to re-examine its approach and look for ways to deliver a deeper developmental impact. Sonu Goyal is affiliated with International Management Institute.

Case Authors : Sonu Goyal

Topic : Leadership & Managing People

Related Areas : International business

Calculating Net Present Value (NPV) at 6% for AIACA: Interventions for Sustainable Livelihoods Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10013751) -10013751 - -
Year 1 3472363 -6541388 3472363 0.9434 3275814
Year 2 3964513 -2576875 7436876 0.89 3528402
Year 3 3963975 1387100 11400851 0.8396 3328230
Year 4 3245144 4632244 14645995 0.7921 2570458
TOTAL 14645995 12702904

The Net Present Value at 6% discount rate is 2689153

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. Payback Period
2. Net Present Value
3. Profitability Index
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. Timing of the expected cash flows – stockholders of Aiaca Craftworkers 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. Aiaca Craftworkers 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 AIACA: Interventions for Sustainable Livelihoods

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 Aiaca Craftworkers 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 Aiaca Craftworkers 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 %
Cash Flows
Year 0 (10013751) -10013751 - -
Year 1 3472363 -6541388 3472363 0.8696 3019446
Year 2 3964513 -2576875 7436876 0.7561 2997741
Year 3 3963975 1387100 11400851 0.6575 2606378
Year 4 3245144 4632244 14645995 0.5718 1855422
TOTAL 10478987

The Net NPV after 4 years is 465236

(10478987 - 10013751 )

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 %
Cash Flows
Year 0 (10013751) -10013751 - -
Year 1 3472363 -6541388 3472363 0.8333 2893636
Year 2 3964513 -2576875 7436876 0.6944 2753134
Year 3 3963975 1387100 11400851 0.5787 2293967
Year 4 3245144 4632244 14645995 0.4823 1564981
TOTAL 9505718

The Net NPV after 4 years is -508033

At 20% discount rate the NPV is negative (9505718 - 10013751 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Aiaca Craftworkers 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 Aiaca Craftworkers has a NPV value higher than Zero then finance managers at Aiaca Craftworkers 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 Aiaca Craftworkers, then the stock price of the Aiaca Craftworkers 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 Aiaca Craftworkers 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 will be a multi year spillover effect of various taxation regulations.

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

Sonu Goyal (2018), "AIACA: Interventions for Sustainable Livelihoods Harvard Business Review Case Study. Published by HBR Publications.