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EDM (Energie du Mali) 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 EDM (Energie du Mali) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. EDM (Energie du Mali) case study is a Harvard Business School (HBR) case study written by Jose Gomez-Ibanez. The EDM (Energie du Mali) (referred as “Edm Mali” 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, Conflict, Corporate governance, Economy, Financial management, Government, International business, Negotiations, Operations management.

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 EDM (Energie du Mali) Case Study


In the spring of 2005, the government of Mali was negotiating major changes in the concession of Energie du Mali (EDM), the private firm that operated Mali's electricity and water services. The negotiations were being watched anxiously by the World Bank and the French bilateral aid agency, who had been promoting private participation as a mechanism for improving performance and increasing investment in infrastructure. The policy had had mixed results around the world, with many successes but also a number of high profile failures. But it had experienced the most difficulty in sub-Saharan Africa, where interest from private investors had been weaker, a relatively high proportion of the private concessions, leases, or management contracts had been cancelled and a number of others, like EDM, were in crisis. This case is designed to illustrate the difficulties of reforming state-owned enterprises in small and poor countries like many of those in sub-Saharan Africa. It can also be used to discuss the strengths and weaknesses of different forms of private participation including concessions, leases, and management contracts. HKS Case Number 1811.0


Case Authors : Jose Gomez-Ibanez

Topic : Leadership & Managing People

Related Areas : Conflict, Corporate governance, Economy, Financial management, Government, International business, Negotiations, Operations management




Calculating Net Present Value (NPV) at 6% for EDM (Energie du Mali) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10015567) -10015567 - -
Year 1 3466130 -6549437 3466130 0.9434 3269934
Year 2 3979672 -2569765 7445802 0.89 3541894
Year 3 3936757 1366992 11382559 0.8396 3305377
Year 4 3241018 4608010 14623577 0.7921 2567190
TOTAL 14623577 12684395




The Net Present Value at 6% discount rate is 2668828

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. Net Present Value
2. Profitability Index
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. Edm Mali 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 Edm Mali 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 EDM (Energie du Mali)

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 Edm Mali 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 Edm Mali 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 (10015567) -10015567 - -
Year 1 3466130 -6549437 3466130 0.8696 3014026
Year 2 3979672 -2569765 7445802 0.7561 3009204
Year 3 3936757 1366992 11382559 0.6575 2588482
Year 4 3241018 4608010 14623577 0.5718 1853063
TOTAL 10464774


The Net NPV after 4 years is 449207

(10464774 - 10015567 )








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 (10015567) -10015567 - -
Year 1 3466130 -6549437 3466130 0.8333 2888442
Year 2 3979672 -2569765 7445802 0.6944 2763661
Year 3 3936757 1366992 11382559 0.5787 2278216
Year 4 3241018 4608010 14623577 0.4823 1562991
TOTAL 9493310


The Net NPV after 4 years is -522257

At 20% discount rate the NPV is negative (9493310 - 10015567 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Edm Mali 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 Edm Mali has a NPV value higher than Zero then finance managers at Edm Mali 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 Edm Mali, then the stock price of the Edm Mali 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 Edm Mali 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 uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

Understanding of risks involved in the project.

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.

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.






Negotiation Strategy of EDM (Energie du Mali)

References & Further Readings

Jose Gomez-Ibanez (2018), "EDM (Energie du Mali) Harvard Business Review Case Study. Published by HBR Publications.


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