Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?
At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. DISNEYLAND RESORT PARIS: MICKEY GOES TO EUROPE case study is a Harvard Business School (HBR) case study written by Martha Maznevski, Karsten Jonsen. The DISNEYLAND RESORT PARIS: MICKEY GOES TO EUROPE (referred as “Disneyland Resort” 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, Globalization, Organizational culture.
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.
The case tracks the story of Disneyland Resort Paris from its opening in 1992 until the end of 2006, illustrating how the resort's managers learned from their initial errors how to take a strong cultural product (the Disney experience) and implement it effectively in a multicultural environment. However, by the end of 2006 the park was still not profitable and the managers were hoping for 2007, the Park's 25th anniversary season, being a turnaround year. The case presents the dilemma of global integration vs local adaptation in a multicultural and culturally-sensitive environment.It draws upon unique insights from some of historic key players as well as the current ones and sets up situations that can be interpreted from different roles in an organization (marketing, operations, senior management, etc.) and some of the issues they faced being the first multi-cultural Disney theme park in the world. Disneyland Resort Paris opened its gates in April 1992 amidst enormous controversy as a bastion of American cultural imperialism in Europe. By 2006 it was the most visited tourist site in Europe with over 12 million annual visitors. In spite of a difficult tourist industry in the early 2000s, Disneyland Resort Paris's attendance remained stable: 60% of its visitors were repeat visitors, and guest satisfaction was extremely high. The operation had created 43,000 jobs, invested more than a??5 billion and contributed to the development of a new region. As the leaders developed their execution plans, they wondered what principles should guide them and how to interpret Disney in multicultural Europe. Guests from different parts of Europe wanted different things from a vacation: how could they keep the classic Disney magic yet successfully appeal to European consumers? After 15 years of switching between French and American leadership, the answers were still not obvious. The leaders agreed that the 2007 celebrations of its 15th anniversary should set the scene for Disney's recognition as a well established experience in the heart of Europe, and a long-term financial success. But what would it look like and what path would take them there? Learning objectives: The case was written to support two teaching objectives; the class can focus on one or both depending on time and instructor objectives. It raises issues that can be dealt with through perspectives of organizational behaviour, general management and marketing. 1. Identifying the complex role of national or ethnic cultures in multinational firms. Disneyland Resorts were "selling" one culture (idealistic American culture) to guests from many cultures, and only started to become successful when they could articulate cultural issues well. 2. Working with the global standardization vs local adaptation tension. Disneyland Resorts could be neither completely standardized nor adapted. Finding an "intermediate" solution is not obvious but is key to managing the Resort for high performance.
| Years | Cash Flow | Net Cash Flow | Cumulative Cash Flow |
Discount Rate @ 6 % |
Discounted Cash Flows |
|---|---|---|---|---|---|
| Year 0 | (10019306) | -10019306 | - | - | |
| Year 1 | 3459555 | -6559751 | 3459555 | 0.9434 | 3263731 |
| Year 2 | 3979764 | -2579987 | 7439319 | 0.89 | 3541976 |
| Year 3 | 3954644 | 1374657 | 11393963 | 0.8396 | 3320395 |
| Year 4 | 3249613 | 4624270 | 14643576 | 0.7921 | 2573998 |
| TOTAL | 14643576 | 12700100 |
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 -
Capital Budgeting Approaches
There are four types of capital budgeting techniques that are widely used in the corporate world –
1. Net Present Value
2. Payback Period
3. Internal Rate of Return
4. Profitability Index
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. Disneyland Resort 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 Disneyland Resort have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
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
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 Disneyland Resort 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 Disneyland Resort 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.
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 | (10019306) | -10019306 | - | - | |
| Year 1 | 3459555 | -6559751 | 3459555 | 0.8696 | 3008309 |
| Year 2 | 3979764 | -2579987 | 7439319 | 0.7561 | 3009273 |
| Year 3 | 3954644 | 1374657 | 11393963 | 0.6575 | 2600243 |
| Year 4 | 3249613 | 4624270 | 14643576 | 0.5718 | 1857977 |
| TOTAL | 10475801 |
(10475801 - 10019306 )
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 | (10019306) | -10019306 | - | - | |
| Year 1 | 3459555 | -6559751 | 3459555 | 0.8333 | 2882963 |
| Year 2 | 3979764 | -2579987 | 7439319 | 0.6944 | 2763725 |
| Year 3 | 3954644 | 1374657 | 11393963 | 0.5787 | 2288567 |
| Year 4 | 3249613 | 4624270 | 14643576 | 0.4823 | 1567136 |
| TOTAL | 9502391 |
At 20% discount rate the NPV is negative (9502391 - 10019306 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Disneyland Resort to discount cash flow at lower discount rates such as 15%.
Simplest Approach – If the investment project of Disneyland Resort has a NPV value higher than Zero then finance managers at Disneyland Resort 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 Disneyland Resort, then the stock price of the Disneyland Resort 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.
Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Disneyland Resort 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 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.
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.
Martha Maznevski, Karsten Jonsen (2018), "DISNEYLAND RESORT PARIS: MICKEY GOES TO EUROPE Harvard Business Review Case Study. Published by HBR Publications.
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