Q. 149  Using the NPV calculator at https://www.benchmarksixsigma.com/calculators/net-present-value/ and the following data, comment on whether this project should be taken up if this gives a huge increase in Employee Satisfaction scores and Corporate Social Responsibility visibility for this company. 

 

Future Cash Flow - 50,000
Rate of Interest - 8%
Time Period - 2 years
Initial Investment - 42,867

 

  

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NPV is nothing but the present inflow & outflow of the cash normally this is used for capital budgetting of the company or can say available funds/cash with the company

Using the NPV calculator, we got the NPV value as 0.

A zero NPV means that the investment earns a rate of return equal to the discount rate(rate of interest). 

Further, this project is not expected to result in any significant gain or loss for the company. With a neutral NPV, management uses non-monetary factors to decide on the investment.

The non-monetary factors in this project are increase in Employee Satisfaction scores and Corporate Social Responsibility visibility.

Thus we can conclude that the company can/may take up this project if it looks up to bring improvement in the above mentioned factors.

Monetary benefits: As per the calculator, NPV is equal to Zero (=0) which means no profit no loss. Based on this result, we cannot determine if the company has to take up this project or not.

Non-monetary benefits: As this project gives benefits such as huge increase in Employee satisfaction and CSR visibility, this is always a positive point.

 

Final Comment: This project must be taken up by the company considering non-monetary benefits with an assurance of no monetary loss (as per calculated NPV).

Before Analyzing The NPV calculator, let us first understand what NPV is all about:

 

NPV stands for Net Present Value which is one of Discounted Cash Flow Techniques which were developed to take account the time value of money and to improve the accuracy of cash project evaluations. in simple words we can say that NPV is the difference of present value of cash ouflow and future value of cash inflow over a period of time. NPV consists of:

• finding the present value (PV) of each cash flow, discounted at an appropriate percentage rate.
• finding the NPV by adding the discounted net cash flow
• to determine whether the project is acceptable or not.

If two or more projects having positive NPV then the one which is of higher NPV is a more likely choice.

NPV can be positive, negative or zero. Projects with Positive NPV have more return or cash flow or in other words we can say that projects with positive NPV are profitable to the organization but projects with negative or zero NPV is loss to the organizations but it does not mean that we can not go with projects with negative or zero NPV. This will be explained further.

 

Lets understand the calculator with the given values in the question:

 

Future Cash Flow: Amount given is 50000 which is an estimated value when the investment done for the project. Cash flow is the amount which is the increase or decrease in the amount of money for any business. or in other words its the company's ability to create value for shareholders which is determined by its ability to generate positive cash flow. 

For any organization its very important to have good Cash Flow, Profit and Return of Investment(ROI). Any organization can survive with less profit and ROI but it cant go with poor cash flow or if there is no cash flow then it may close down the business in future.  

 

Rate of interest of discount rate: it is the expected rate of interest to compute the present value which is 8 % in above example. discount rate is company specific  because its related to how the company gets its funds. It is the rate of return that the company expect.

 

Time Period: this is the time period after which the cash flow is expected. In above example this is of 2 years. 

 

Initial Investment: This is the amount which is invested initially that is expected to generate future cash flow. in above example this is 42867. 

 

in above example when we put all values in calculator we see that NPV comes zero. but it does not means that zero NPV indicate no value zero NPV means that  investment earns a rate of return equal to discount rate. Because NPV is the measure of wealth creation relative to the discount rate. 

 

In above example we should go with this project as this project gives a huge increase in employee satisfaction scores and corporate responsibility visibility for this company. in above example we have good cash flow which is very good for the organization but has zero NPV. 

 

Sometimes we select projects even negative NPV for example when we are going to buy a new car  then we know that after so many years residual value will be less when we sell it. but still we buy because  things like bus or any cab fairs that we are not going to pay now after buying a car and now we can drive anywhere ,we can go anywhere , there will no need to wait over stations or bus stands so time also saving, so we buy new car when we consider all factors although we know that residual value of car is less.

Another example is that Facebook bought what's app and Instagram yet both are not still profitable because they know if they don't then Google might buy both and get more users on What's App and Instagram. So Facebook has to pay to avoid the user churn. Another example is of safety equipment used in  industries, they all have almost negative NPV but still are used because they are important to ensure people are not getting injured or killed. 

 

Similarly we can select project with Zero NPV because:

• Zero NPV increase revenues despite not increasing profits. because shareholders look to revenue growth as an indicator of financial growth.
• It may involve social benefits that will increase brand value of the organization.
• it may be a part of legal or regulatory requirements.
• it may change in the economic cycle which will lead to project to a positive one.
• As stated in the example it may  give a huge increase in employee satisfaction scores and corporate responsibility visibility for this company.

Benchmark Six Sigma Expert View by Venugopal R

 

Cash in hand has an advantage of having the ability to be invested immediately and enable earning of returns. Hence the value of same amount of cash that we would get in future is always lower than that we have now.

 

Net Present Value compares the value of the amount invested today to the present value of the future returns from the investment, after discounting them to a given rate of return.

 

The answer to the given question may be debatable. The NPV being zero, means that we would be in no profit, no loss situation. Considering the fact that this investment gives tremendous intangible benefits, with no expected loss, it could be a taken up. Further, companies may not strictly go by the NPV alone. It also depends on the assumed discounted rate, which need not be accurate. Another situation that some of us would have come across is when we have multiple projects with a large client, where the gains from all the projects put together for the client is significant, then we can afford to take a project even with a negative NPV to retain the overall good will of the client partnership. Some companies have good continuous improvement practices in place and will have the confidence of bringing about adequate process improvements within couple of years and make the project profitable.

 

However, if there are other evidently lucrative investment opportunities available, it may not make sense in going ahead with this project, unless the need for the Employee Satisfaction and CSR heavily over weigh the tangible benefits from the other projects.

NPV is a financial calculation that helps convert all future cash inflows into today's value given the time value of money (keeping in mind that the value of money depreciates with time). This conversion allows for an apples to apples comparison between cash flow today and over the coming years and hence do a net profit calculation. This calculation is one way of ascertaining if there is a merit in taking a project up or not.

 

Vastupal's answer is the chosen best answer for the level of detail. Read Benchmark expert view given by Venugopal R.