QADRI-GROUP: SUSTAINING BEYOND THE FIRST 100 YEARS 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 QADRI-GROUP: SUSTAINING BEYOND THE FIRST 100 YEARS case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. QADRI-GROUP: SUSTAINING BEYOND THE FIRST 100 YEARS case study is a Harvard Business School (HBR) case study written by Muhammad Shakeel Sadiq Jajja, Syed Zahoor Hassan. The QADRI-GROUP: SUSTAINING BEYOND THE FIRST 100 YEARS (referred as “Family Qg” 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, Entrepreneurship, Managing people.

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 QADRI-GROUP: SUSTAINING BEYOND THE FIRST 100 YEARS Case Study

The case describes the situation of over a hundred years old, family-owned, and male-managed business group - Qadri-Group (QG). QG was facing challenges in family's interplay with the group's business. Meanwhile QG also foresaw several new business opportunities and challenges in domestic and international markets that required greater focus and harmony among the family members and group companies. QG's Board of Directors (BoD) felt that a unanimously formulated Family Constitution was needed to manage the increasing complexity in the family and ownership, as the group ventured out to benefit from the emerging business landscape. Rizwan, a third generation family member of the BoD, initiated and advocated the idea of developing a family constitution as soon as possible to address the complex and lingering matters that the family faced. Rizwan appreciated that the challenges related to involvement of the family's fourth generation in the business and ownership would complicate the situation in subsequent years, during which more challenges related to QG business were also anticipated. He took on the responsibility to provide suggestions on how to govern increased family complexity (in terms of diversity of educational backgrounds, allocation of incentives to family members according to their profiles, involvement of daughters and their in-laws in QG's business etc.) and business complexity. Rizwan Qadri hoped that his suggestions related to the formulation of the family constitution would help address the following issues: 1. clarity on the issue of employment of daughters and daughters-in-law in the business 2. involvement of in-laws (unrelated by blood) in the family business 3. compensation for family members; competitive and merit based career planning Also he had to give suggestions for the process to be followed for arriving at a mutually agreed family constitution.

Case Authors : Muhammad Shakeel Sadiq Jajja, Syed Zahoor Hassan

Topic : Leadership & Managing People

Related Areas : Entrepreneurship, Managing people

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Calculating Net Present Value (NPV) at 6% for QADRI-GROUP: SUSTAINING BEYOND THE FIRST 100 YEARS Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10026309)	-10026309	-	-
Year 1	3452158	-6574151	3452158	0.9434	3256753
Year 2	3973470	-2600681	7425628	0.89	3536374
Year 3	3973963	1373282	11399591	0.8396	3336616
Year 4	3248432	4621714	14648023	0.7921	2573062
TOTAL			14648023		12702805

The Net Present Value at 6% discount rate is 2676496

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. 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 Family Qg 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. Family Qg 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 QADRI-GROUP: SUSTAINING BEYOND THE FIRST 100 YEARS

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 Family Qg 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 Family Qg 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	(10026309)	-10026309	-	-
Year 1	3452158	-6574151	3452158	0.8696	3001877
Year 2	3973470	-2600681	7425628	0.7561	3004514
Year 3	3973963	1373282	11399591	0.6575	2612945
Year 4	3248432	4621714	14648023	0.5718	1857302
TOTAL					10476637

The Net NPV after 4 years is 450328

(10476637 - 10026309 )

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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	(10026309)	-10026309	-	-
Year 1	3452158	-6574151	3452158	0.8333	2876798
Year 2	3973470	-2600681	7425628	0.6944	2759354
Year 3	3973963	1373282	11399591	0.5787	2299747
Year 4	3248432	4621714	14648023	0.4823	1566566
TOTAL					9502466

The Net NPV after 4 years is -523843

At 20% discount rate the NPV is negative (9502466 - 10026309 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Family Qg 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 Family Qg has a NPV value higher than Zero then finance managers at Family Qg 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 Family Qg, then the stock price of the Family Qg 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 Family Qg 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 can impact the cash flow of 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 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 QADRI-GROUP: SUSTAINING BEYOND THE FIRST 100 YEARS

References & Further Readings

Muhammad Shakeel Sadiq Jajja, Syed Zahoor Hassan (2018), "QADRI-GROUP: SUSTAINING BEYOND THE FIRST 100 YEARS Harvard Business Review Case Study. Published by HBR Publications.