Sanergy: Tackling Sanitation in Kenyan Slums 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 Sanergy: Tackling Sanitation in Kenyan Slums case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Sanergy: Tackling Sanitation in Kenyan Slums case study is a Harvard Business School (HBR) case study written by Jennifer Walske, Laura D. Tyson. The Sanergy: Tackling Sanitation in Kenyan Slums (referred as “Sanitation Eleos” 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, Mergers & acquisitions, Social enterprise, 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 Sanergy: Tackling Sanitation in Kenyan Slums Case Study

This case centers on Sanergy, a five-plus-year-old hybrid organization, that has become a high profile, high growth, social enterprise, known initially for its Fresh Life toilets deployed in the Mukuru and Mathare slums of Nairobi, Kenya. Sanergy's co-founders launched their social startup out of the 2011 MIT 100K business plan challenge and quickly received national attention in the press. By 2013, the firm had raised a "Series A" equity round from Acumen, Eleos Investment Management (Eleos) and Novastar, the team had also begun its operations in Kenya to more rapidly build-out both sides of its business: (1) in its non-profit business, deploying Fresh Life Toilets to improving access to hygienic sanitation in Nairobi's informal settlements sanitation business, largely using a franchisee model; and (2) in its for-profit fertilizer business, with its Evergrow Organic Fertilizer, produced by Farm Star, sold to small- and medium-sized farmers in need of rich soil supplements. This case examines both Sanergy's hybrid business model and "sustainable sanitation value chain" in detail and explores the challenges the social enterprise entity will face as it continues to scale up both businesses and seeks to reach the breakeven point by 2018.

Case Authors : Jennifer Walske, Laura D. Tyson

Topic : Leadership & Managing People

Related Areas : Mergers & acquisitions, Social enterprise, Sustainability

Calculating Net Present Value (NPV) at 6% for Sanergy: Tackling Sanitation in Kenyan Slums Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10005957) -10005957 - -
Year 1 3473128 -6532829 3473128 0.9434 3276536
Year 2 3965740 -2567089 7438868 0.89 3529494
Year 3 3968809 1401720 11407677 0.8396 3332289
Year 4 3245692 4647412 14653369 0.7921 2570892
TOTAL 14653369 12709211

The Net Present Value at 6% discount rate is 2703254

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

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. Sanitation Eleos 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 Sanitation Eleos 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 Sanergy: Tackling Sanitation in Kenyan Slums

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 Sanitation Eleos 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 Sanitation Eleos 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 (10005957) -10005957 - -
Year 1 3473128 -6532829 3473128 0.8696 3020111
Year 2 3965740 -2567089 7438868 0.7561 2998669
Year 3 3968809 1401720 11407677 0.6575 2609556
Year 4 3245692 4647412 14653369 0.5718 1855735
TOTAL 10484072

The Net NPV after 4 years is 478115

(10484072 - 10005957 )

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 (10005957) -10005957 - -
Year 1 3473128 -6532829 3473128 0.8333 2894273
Year 2 3965740 -2567089 7438868 0.6944 2753986
Year 3 3968809 1401720 11407677 0.5787 2296764
Year 4 3245692 4647412 14653369 0.4823 1565245
TOTAL 9510269

The Net NPV after 4 years is -495688

At 20% discount rate the NPV is negative (9510269 - 10005957 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Sanitation Eleos 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 Sanitation Eleos has a NPV value higher than Zero then finance managers at Sanitation Eleos 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 Sanitation Eleos, then the stock price of the Sanitation Eleos 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 Sanitation Eleos 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 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.

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

Jennifer Walske, Laura D. Tyson (2018), "Sanergy: Tackling Sanitation in Kenyan Slums Harvard Business Review Case Study. Published by HBR Publications.