Fogdog 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 Fogdog case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Fogdog case study is a Harvard Business School (HBR) case study written by John W. Glynn Jr., Christopher S. Flanagan. The Fogdog (referred as “Fogdog Sale” 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, Mergers & acquisitions, Venture capital.

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

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Case Description of Fogdog Case Study

This case examines the growth and development of Fogdog, an online sporting goods retailer, from its founding through multiple rounds of venture capital financing to an IPO and, ultimately, to its sale to Global Sports--one of its publicly traded competitors. The Fogdog story is set in the late 1990s, when the Internet economy was virtually exploding with new opportunities. Built to capitalize on the new Internet medium, Fogdog faced a number of issues specific to the unique economic climate surrounding the company at the time. However, the company also faced a number of timeless issues that many emerging companies experience, such as board composition and development, communication between a company and its board, and the respective positions and responsibilities of both management and a company's investors when tough company decisions have to be made. Woven throughout the case are additional themes of hiring management, raising capital, and forming strategic alliances. It ends with the "forced" sale of Fogdog by the company's board at a time when the near-term outlook for Internet-related companies was uncertain. This sale took place despite management's stated desire to continue running the company.

Case Authors : John W. Glynn Jr., Christopher S. Flanagan

Topic : Leadership & Managing People

Related Areas : Mergers & acquisitions, Venture capital

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Calculating Net Present Value (NPV) at 6% for Fogdog Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10001807)	-10001807	-	-
Year 1	3450514	-6551293	3450514	0.9434	3255202
Year 2	3981563	-2569730	7432077	0.89	3543577
Year 3	3936899	1367169	11368976	0.8396	3305496
Year 4	3230076	4597245	14599052	0.7921	2558523
TOTAL			14599052		12662798

The Net Present Value at 6% discount rate is 2660991

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.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Payback Period
2. Profitability Index
3. Net Present Value
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. Timing of the expected cash flows – stockholders of Fogdog Sale have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Fogdog Sale shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Fogdog

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 Fogdog Sale 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 Fogdog Sale 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	(10001807)	-10001807	-	-
Year 1	3450514	-6551293	3450514	0.8696	3000447
Year 2	3981563	-2569730	7432077	0.7561	3010634
Year 3	3936899	1367169	11368976	0.6575	2588575
Year 4	3230076	4597245	14599052	0.5718	1846806
TOTAL					10446462

The Net NPV after 4 years is 444655

(10446462 - 10001807 )

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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	(10001807)	-10001807	-	-
Year 1	3450514	-6551293	3450514	0.8333	2875428
Year 2	3981563	-2569730	7432077	0.6944	2764974
Year 3	3936899	1367169	11368976	0.5787	2278298
Year 4	3230076	4597245	14599052	0.4823	1557714
TOTAL					9476415

The Net NPV after 4 years is -525392

At 20% discount rate the NPV is negative (9476415 - 10001807 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Fogdog Sale 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 Fogdog Sale has a NPV value higher than Zero then finance managers at Fogdog Sale 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 Fogdog Sale, then the stock price of the Fogdog Sale 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 Fogdog Sale 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 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.

What will be a multi year spillover effect of various taxation regulations.

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.

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.

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Negotiation Strategy of Fogdog

References & Further Readings

John W. Glynn Jr., Christopher S. Flanagan (2018), "Fogdog Harvard Business Review Case Study. Published by HBR Publications.