×




McKay Nursery Co. (A) 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 McKay Nursery Co. (A) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. McKay Nursery Co. (A) case study is a Harvard Business School (HBR) case study written by Kathleen Meyer, Laura Pochop, Stephen Weiss. The McKay Nursery Co. (A) (referred as “Mckay Nursery” 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, Ethics, Human resource management, Social enterprise.

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 McKay Nursery Co. (A) Case Study


McKay Nursery Co., founded in 1897 in Waterloo, Wisconsin, had a longstanding history of commitment to employees. The close-knit organization was a pioneer in the agricultural industry of several employee-friendly policies. But in the early 1980s, as McKay's owners grew older and senior management neared retirement, the next generation of managers feared for the future of the profitable, debt-free company. Middle manager Griff Mason and his colleagues were concerned McKay might become the target of a hostile takeover, which would move the company out of the community that had supported it for nearly a century. They wondered what they might do to keep the company in Waterloo and continue to retain its employees, nearly half of whom were migrant workers.


Case Authors : Kathleen Meyer, Laura Pochop, Stephen Weiss

Topic : Leadership & Managing People

Related Areas : Ethics, Human resource management, Social enterprise




Calculating Net Present Value (NPV) at 6% for McKay Nursery Co. (A) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10002555) -10002555 - -
Year 1 3453894 -6548661 3453894 0.9434 3258391
Year 2 3970146 -2578515 7424040 0.89 3533416
Year 3 3955876 1377361 11379916 0.8396 3321430
Year 4 3230013 4607374 14609929 0.7921 2558473
TOTAL 14609929 12671709




The Net Present Value at 6% discount rate is 2669154

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. Profitability Index
2. Internal Rate of Return
3. Net Present Value
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. Mckay Nursery 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 Mckay Nursery 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 McKay Nursery Co. (A)

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 Mckay Nursery 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 Mckay Nursery 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 (10002555) -10002555 - -
Year 1 3453894 -6548661 3453894 0.8696 3003386
Year 2 3970146 -2578515 7424040 0.7561 3002001
Year 3 3955876 1377361 11379916 0.6575 2601053
Year 4 3230013 4607374 14609929 0.5718 1846770
TOTAL 10453210


The Net NPV after 4 years is 450655

(10453210 - 10002555 )








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 (10002555) -10002555 - -
Year 1 3453894 -6548661 3453894 0.8333 2878245
Year 2 3970146 -2578515 7424040 0.6944 2757046
Year 3 3955876 1377361 11379916 0.5787 2289280
Year 4 3230013 4607374 14609929 0.4823 1557684
TOTAL 9482255


The Net NPV after 4 years is -520300

At 20% discount rate the NPV is negative (9482255 - 10002555 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Mckay Nursery 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 Mckay Nursery has a NPV value higher than Zero then finance managers at Mckay Nursery 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 Mckay Nursery, then the stock price of the Mckay Nursery 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 Mckay Nursery 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 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.

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 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.






Negotiation Strategy of McKay Nursery Co. (A)

References & Further Readings

Kathleen Meyer, Laura Pochop, Stephen Weiss (2018), "McKay Nursery Co. (A) Harvard Business Review Case Study. Published by HBR Publications.


TLG Immobilien AG SWOT Analysis / TOWS Matrix

Services , Real Estate Operations


Electro-Sensors SWOT Analysis / TOWS Matrix

Technology , Scientific & Technical Instr.


Solar Capital SWOT Analysis / TOWS Matrix

Financial , Misc. Financial Services


Pfizer SWOT Analysis / TOWS Matrix

Healthcare , Biotechnology & Drugs


Aperam SWOT Analysis / TOWS Matrix

Basic Materials , Iron & Steel


Directa Plus SWOT Analysis / TOWS Matrix

Capital Goods , Constr. - Supplies & Fixtures


Shinkawa Ltd SWOT Analysis / TOWS Matrix

Capital Goods , Misc. Capital Goods