Thakur Engineering Works: Treading into the Future 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 Thakur Engineering Works: Treading into the Future case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Thakur Engineering Works: Treading into the Future case study is a Harvard Business School (HBR) case study written by Meenakshi Jakhar, Manoj Kumar Srivastava. The Thakur Engineering Works: Treading into the Future (referred as “Tew Thakur” 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, Manufacturing.

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 Thakur Engineering Works: Treading into the Future Case Study

At the end of 2014, the owner of India-based Thakur Engineering Works (TEW) was at a crossroads in determining his company's future. After more than two decades of solidly building the family business's reputation at home, the producer and supplier of auto parts was poised for expansion either domestically or globally. TEW already produced parts that were shipped overseas via domestic exporters. The owner could not help but wonder about the possibility of simply shipping the parts directly to foreign clients. While that decision would require changes to its logistics and operations and would incur costs related to exports, the owner could not ignore the pay-off in profits. In India, the auto parts market was experiencing a slowdown, resulting in fierce competition, price reductions, and pressure to deliver parts faster. Despite these challenges, the Indian market was one he understood, so expansion there carried little risk. Should TEW continue to focus on increasing its market position domestically or was the time right for TEW to target the more profitable global market? Meenakshi Jakhar is affiliated with Management Development Institute. Manoj Kumar Srivastava is affiliated with Management Development Institute.

Case Authors : Meenakshi Jakhar, Manoj Kumar Srivastava

Topic : Leadership & Managing People

Related Areas : Manufacturing

Calculating Net Present Value (NPV) at 6% for Thakur Engineering Works: Treading into the Future Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10014095) -10014095 - -
Year 1 3464797 -6549298 3464797 0.9434 3268676
Year 2 3953604 -2595694 7418401 0.89 3518693
Year 3 3956475 1360781 11374876 0.8396 3321933
Year 4 3225637 4586418 14600513 0.7921 2555007
TOTAL 14600513 12664309

The Net Present Value at 6% discount rate is 2650214

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. Internal Rate of Return
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 Tew Thakur 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. Tew Thakur 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 Thakur Engineering Works: Treading into the Future

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 Tew Thakur 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 Tew Thakur 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 (10014095) -10014095 - -
Year 1 3464797 -6549298 3464797 0.8696 3012867
Year 2 3953604 -2595694 7418401 0.7561 2989493
Year 3 3956475 1360781 11374876 0.6575 2601447
Year 4 3225637 4586418 14600513 0.5718 1844268
TOTAL 10448075

The Net NPV after 4 years is 433980

(10448075 - 10014095 )

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 (10014095) -10014095 - -
Year 1 3464797 -6549298 3464797 0.8333 2887331
Year 2 3953604 -2595694 7418401 0.6944 2745558
Year 3 3956475 1360781 11374876 0.5787 2289627
Year 4 3225637 4586418 14600513 0.4823 1555573
TOTAL 9478089

The Net NPV after 4 years is -536006

At 20% discount rate the NPV is negative (9478089 - 10014095 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Tew Thakur 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 Tew Thakur has a NPV value higher than Zero then finance managers at Tew Thakur 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 Tew Thakur, then the stock price of the Tew Thakur 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 Tew Thakur 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 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 can impact the cash flow of the project.

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.

References & Further Readings

Meenakshi Jakhar, Manoj Kumar Srivastava (2018), "Thakur Engineering Works: Treading into the Future Harvard Business Review Case Study. Published by HBR Publications.