Financial Evaluation of a Project in Grameenphone Network Operation

The purpose of this report is to determine the financial evaluation of a project within Grameenphone Network Operation, report also focus and discuss  Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period and Return on Investment (ROI) techniques. Finally identify some limitations with the procedure that is followed at Grameenphone, Network Operation and to provide recommendations.

Introduction

Projects are an inseparable part of any organization. The scope of projects within a telecommunication firm can vary within a wide range including installation of new systems, short or long term marketing campaign for increasing revenue, increasing cost-efficiency. But, every project involves financial resources in terms of capital, labor etc. Thus, before initiating any project, a financial evaluation is mandatory to determine whether the outcome will be able to overcome the initial capital investment and whether it will be able to generate profit greater than the risk free rate. This report focuses on determining the financial viability of a project within Grameenphone Network Operation by employing the Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period and Return on Investment (ROI) techniques.

Objectives:

The objectives of the report are

• To understand how projects are initiated and run at Grameenphone, Network Operation.
• To perform the financial evaluation of a project to determine whether it will provide return over the invested capital with the standard procedure followed at Grameenphone, Network Operation.
• To identify the limitations with the procedure that is followed at Grameenphone, Network Operation and to provide recommendations.

Methodology:

Selection of the topic:

The topic selected for the study was assigned by the supervisor at Grameenphone, Network operation.

Data Source:

Information used in this report has been collected from both primary and secondary sources. The primary sources are

• Practical desk work
• Data sheet of vendors
• Earlier stored data archived for future use
• Financial data collected from different departments
• Face to face conversation and meeting with different stakeholders

While the secondary sources are

• Different ‘Procedure Manual’ of Grameenphone, Network Operation
• Books, publications, websites.

Company Introduction:

Grameenphone is the largest cellular operator in the country. It is a joint venture enterprise between Telenor and Grameen Telecom Corporation, a non-profit sister concern of the internationally acclaimed microfinance organization and community development bank Grameen Bank. Telenor, the largest telecommunications company in Norway, owns 55.8% shares of Grameenphone, Grameen Telecom owns the remaining 34.2% 2 and the other 10% shares belong to the general retail and institutional investors.

Grameenphone was the first company to introduce GSM technology in Bangladesh. It was offered the cellular license in Bangladesh by the Ministry of Posts and Telecommunications in the year 1996. Grameenphone launched its service on the Independence day, 26th March, 1997.

It also established the first 24-hour Call Center to support its subscribers. With the slogan Stay Close, stated goal of Grameenphone is to provide affordable telephony to the entire population of Bangladesh.

After almost 10 years of operation, Grameenphone had over 10 million subscribers and it is now the leading telecommunications service provider in the country with more than 29.97 million subscribers as of December 2010.

In the fast-paced world of telecommunications, vibrant and dynamic Corporate Governance practices are an essential ingredient to success. Grameenphone believes in the continued improvement of corporate governance. This in turn has led the Company to commit considerable resources and implement internationally accepted Corporate Standards in its day-to-day operations.

Vision and Mission Statements:

Vision: To be leading provider of telecommunication services all over Bangladesh with satisfied customers and shareholders, and enthusiastic employees.

Mission: Grameenphone Ltd. aims at providing reliable, widespread, convenient mobile and cost effective telephone services to the people in Bangladesh irrespective of where they live. Such services will also help Bangladesh keep pace with other countries including those in South Africa region and reducing her existing disparity in telecom services between urban and rural areas.

Financial Evaluation of the Project

In a climate of increasing financial control, it is more important than ever that investment analysis is of a high standard. Investments can have many risks that can keep away many potential investors. To avoid this to happen, the most accurate financial/economical analysis has to be made. Financial evaluation is a rational method for making choices .Any good commercial organization should be able to identify more viable investment opportunities than it has money to invest in, so it has to choose which projects to fund.

Objectives of Financial Evaluation:

The objectives of economic evaluation are:

• To decide which investments will make the best use of the organization’s money?
• To ensure that the optimum benefits are available from each of these investments.
• To minimize any risk to the organization.
• To provide a basis for the later analysis of the performance of each investment.

The process of economic evaluation:

• Produces measures of the financial improvement that each project could make to the business.
• Identifies the risks and uncertainties in each project.
• Defines the expected costs and benefits.

The decision maker can the use the results of the evaluation to choose between projects. Financial evaluation helps organizations make the right choices. However, as projects to improve energy efficiency are likely to be competing for funds against other projects, what is really being evaluated is project’s position within a list of possibilities. To give energy projects the best chance of being funded, an economic evaluation should be presented with the proposal. The decision maker will then be able to compare the benefits of the energy project directly with the other investment proposals.

Key Stages in Financial Evaluation:

Financial evaluation produce financial measures of the potential of each of the possible investments open to the organization. These measures can then be used to decide which projects should be funded and the priority they should be given. Financial evaluation tries to show the benefits of projects in relation to their capital costs; however, it is often difficult to find any single parameter which measures this. There are many different measures that can be used for economic evaluation, each of which highlights a different aspect of a project. No one measure is better than any other, and each as its strengths and weaknesses.

Cash Flow:

The first step in any economic evaluation is to gather the information on the project costs and benefits and calculate the cash flows. This gives a statement of how much money will be spent or will be earned in each year of the project.

To determine the cash flow for a project, the costs and savings must be collected for the years in which they occur. The cash flow for each year is found by adding the savings (Positive amounts) to the costs (Negative amounts) for that year. According to the type of project, prediction of the cash flows becomes more or less difficult. There are even cases where a quantitative estimation is almost impossible and the financial evaluation becomes almost unfeasible.

In our case study we considered battery cells as a substitution investment. The cost savings, namely the conservation and maintenance cost savings are known and they can be predicted with a satisfactory degree of accuracy.

Financial Evaluation Techniques

Net Present Value (NPV):

NPV is the difference between the present value of cash inflows and the present value of cash outflows. NPV is used in capital budgeting to analyze the profitability of an investment or project. NPV analysis is sensitive to the reliability of future cash inflows that an investment or project will yield.

The NPV is a financial parameter of particular interest to the financial manager, because it indicates the amount that the project will earn for the business over its expected lifetime in today’s money. If the NPV is positive, the project is viable. If the NPV has been calculated using a realistic discount rate, it can provide information on how to finance the project. For example, the current interest rate to borrow the capital required could be used as a realistic discount rate. If the NPV is negative, it would not be worthwhile borrowing the money for the project. A positive NPV would show the project could repay the loan and still give the investing organization a profit.

Internal Rate of Return (IRR):

IRR is the discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. Generally speaking, the higher a project’s internal rate of return, the more desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects a firm is considering. Assuming all other factors are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first.

The IRR measures the project’s profitability. It represents the rate of return that money would have to earn if invested outside, or elsewhere in the organization on another project, to be a better investment than the project being proposed. The higher the IRR, the better the project is.

As with NP, the IRR can help assess ways of financing the project. The IRR can be compared with the current interest rate for borrowing the capital required .If the IRR is lower than this interest rate, the project would lose money if it was financed by borrowing. If the IRR is greater than the cost of borrowing the capital, the project will generate enough income to repay the loan and still provide profit.

Payback Period:

It is the length of time required to recover the cost of an investment.

Calculated as: Cost of project/Annual cash inflows

The easiest financial parameter to calculate is simple payback, which is defined as the capital cost divided by the average annual savings. Using Payback has some obvious benefits like ease of calculation, tangibility and accuracy, but Payback has some serious disadvantages like it takes no account of any savings after the Payback period and it does not take into account any income from reselling the capital asset later on.

Payback, however, is an useful screening method for projects. A project with a Payback of a few months clearly deserves further investigation, whereas a project with a Payback of 10 years would usually have little chance to receiving funding.

Return on Investment (ROI):

A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio.

The return on investment formula: [(Gain from investment – Cost of investment) / Cost of investment]

In the above formula “gains from investment”, refers to the proceeds obtained from selling the investment of interest.  Return on investment is a very popular metric because of its versatility and simplicity. That is, if an investment does not have a positive ROI, or if there are other opportunities with a higher ROI, then the investment should be not be undertaken.

ROI > 1 means that the is profitable

ROI < 1 means that for the discount rate used the NPV < 0 and the project is not profitable.

Financial Evaluation of the Targeted Project:

In the Financial Evaluation of the project, Addition of 350 Battery Units in BTS, we have tried to determine whether the project is financially viable by calculating Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period and Return on Investment (ROI) by first determining the Cash Flows during the lifetime of the project. The following information have been taken into consideration while determining the Cash Flows

1. 300 sets of batteries will be make 300 generators free. Therefore, 300 generators will be offloaded by adding these 300 sets of batteries.
2. Battery lifetime has been considered as 36 months but savings is calculated for 32 months considering any los due to any unwanted situation.
3. A portion of these 300 sets will be used just for addition with existing batteries to enhance capacity. Rest sets will be used as replacement of existing batteries where some cells are faulty.
4. After installing 300 sets we’ll make 50 sets free from some sites which will be used to reduce outage in some additional sites.
5. Fuel Cost/Running Hour (RH) is TK. 196 and TK. 225 for Generator and Non-AG (Outage Reduction) respectively.
6. The Weighted Average Cost of Capital (WACC) has been accepted as 15.6% and the lifetime of the project has been taken as 3 years.
7. All the figures are in TK.

Capital Expenditure (CaPex):

Table: Capital Expenditure Calculation

Generator Deployment Plan:

 Table: Generator Deployment Plan

Detailed Breakdown of Savings:

Table: Savings Breakdown

Saving Calculation:

Table: Savings Calculation

Cost Benefit Analysis:

Table: Cost Benefit Analysis

Conclusion

Here, first we have calculated the cash inflows and outflows and from those, the Net Cash Flow in each year. Then, using the WACC of 15.60% for discounting the Cash Flows, the NPV has been determined and using Excel formula, Internal Rate of Return (IRR), Payback Period and Return on Investment (ROI) has been calculated. These have yielded

Net Present Value (NPV) = TK 38,118,489

Internal rate of Return (IRR) = 42%

Payback Period = 1.98 years

Return on Investment (ROI) = 50%

NPV determines whether a project earns more or less than a desired rate of return (also called the hurdle rate) and is good at finding out whether or not a project is going to be profitable. NPV is the difference between an investment’s market value and its costs, a positive NPV means that we will derive a single dollar value for the investment today even though the life of the project may span many years. Thus a positive NPV of TK. 38,118,489 has prompted us to go ahead with the project.

IRR goes one step further than NPV to determine a specific rate of return for a project. The IRR is the interest rate that makes the value of the discounted cash flows equal to zero. The project selection rule is:

The rate R delivers the net present value. Here we have used R=WACC (15.60%), which have yielded an IRR of 42% which is clearly above R, we have selected this project since, If the discount rate is higher than R and the discounted value is non-negative, then one would think that the IRR rule is delivering a similar evaluation as Net Present Value. In fact, IRR can be consistent with NPV. If the cash flows are normal and the term structure is flat, then the IRR should given the correct evaluation for independent projects.

Both NPV and IRR give us numbers that we can use to compare competing projects or judge the profitability of a single project. But we have also used the Payback Period and ROI for the financial suitability of the project. The payback period is the amount of time needed for an investment to generate cash flows to recover its initial costs.  This concept is widely understood and used, particularly when evaluating IT projects.  To calculate the Payback Period, we have discounted the Net Cash Flows of each year with the WACC and then used Excel formula to determine the Payback Period to be 1.98 year.

The payback rule says to accept independent projects if

Where N^c represents the life of the investment project. Here N^c = 3 years, thus with a Payback Period of 1.98 years, the project is acceptable to us.

Finally the Return of Investment (ROI) has been calculated at 50%, demonstrating healthy return on Investment, increasing the financial attractiveness of the project.

Thus, considering all of the four variables, namely NPV, IRR, Payback Period and ROI, we have determined the project of “350 Battery Units addition to BTS” is financially suitable to undertake.

Recommendations

Although the analysis of a combination of NPV, IRR, and ROI is somehow comprehensive to determine the financial potential of a project, one serious problem with using ROI as the basis for decision making, is that ROI by itself says nothing about the likelihood that expected returns and costs will appear as predicted. ROI by itself, that is, says nothing about the risk of an investment. ROI simply shows how returns compare to costs if the action or investment brings the results hoped for. The same is also true of other financial metrics, such as NPV, or IRR. For that reason, a good business case or a good investment analysis will also measure the probabilities of different NPV, IRR, ROI outcomes, and wise decision makers will consider both the magnitude and the risks that go with it.

The financial evaluation of projects based on factors like NPV, IRR, ROI, and Payback Period provides optimal result when they are used in comparative problems, i.e. to determine the most suitable option between more than one projects. Although, we have identified our project to be viable based on having positive NPV and ROI, IRR greater than the WACC and a Payback Period greater than the lifetime of the project, this evaluation would have provided better result, if we have selected a set of projects for increasing the Cost Efficiency by reducing Operational Expenditure (OpEx) and then determining the optimal choice by comparing those factors for different selections.

The effect of Inflation has been ignored. Inflation can have a major impact upon the capital budgeting decision. At one level, the expectation of inflation is captured in the nominal interest rate. The discount rate that we use in evaluating the present value of a project is a function of the nominal interest rate as well as the risk of the cash flows. The real rate of interest (nominal interest rate less expected inflation) is less volatile than the nominal rate. At another level, the cash flows of the project could be affected by the inflation rate. If nominal interest rates reflect expected inflation, then we should make sure that the cash flows that we are discounting also reflect expected inflation.

Tax plays an important role in any financial decision. Any benefit obtained by achieving cost-efficiency may be offset to a significant extent after paying tax. The real benefit of the project after tax has not been considered in this analysis. Also, the mixture of capital plays an important role in determining the net tax payable. By ignoring the capital mix and taking into account an companywide accepted value of 15.6%, we have completely ignored any tax benefit that would have been achieved by using a different mix of capital with more equity ratio.

While discounting the Cash Inflows and Outflows, it has been assumed that payment are made or received at the end of the year. As a result, those have been discounted by the yearly Weighted Average Cost of Capital (WACC) whereas, those Cash Flows are a monthly process and in some cases weekly. Also, in the beginning year, Cash Inflow has started from the middle of the year. So, discounting those monthly Cash Flows with monthly WACC would have resulted into more accurate result.

While evaluating the project financially, we have completely ignored different risk factors which may arise without any notice. Risk may be liquidity, solvency or interest or any other like any sudden unexpected cost associated with new equipments being installed which has not been investigated or experienced before. After proper risk analysis, we have to determine whether we have ability to manage these risks, if not, then, we leave that project for projecting our business.

In evaluating the project, no considerations have been given to some important avenues like resell values of Battery Units after the project life time, which may provide a significant Cash Inflow after last year of the project. It could have been possible that without considering this Cash Inflow, this project wouldn’t have been financially lucrative based on those factors, i.e. it would have yielded a negative NPV, ROI or a Payback Period much greater than the project lifetime. Also, the lifetime of the batteries have been determined to be exactly equal to the project lifetime. There is no hard and fast rule that Battery Units will last exactly the same time periods.