Winn-Dixie Stores in 2005 (B): Cleanup on Aisle 11 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 Winn-Dixie Stores in 2005 (B): Cleanup on Aisle 11 case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Winn-Dixie Stores in 2005 (B): Cleanup on Aisle 11 case study is a Harvard Business School (HBR) case study written by James Shein, Evan Meagher. The Winn-Dixie Stores in 2005 (B): Cleanup on Aisle 11 (referred as “Dixie Winn” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Costs, Crisis management, Entrepreneurial management, Financial analysis, Financial markets, Reorganization.

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 Winn-Dixie Stores in 2005 (B): Cleanup on Aisle 11 Case Study

Grocery store chain Winn-Dixie had rapidly expanded in an effort to become a national retailer, and by 1999 it had more than 1,000 stores. The company began manufacturing its own products, reasoning that by owning more of the supply chain, it could offer the customer less expensive options. With its new geographic focus and manufacturing facilities, Winn-Dixie attempted to secure a position as a low-cost provider with a national presence. Instead of improving the company's position in the market, however, this strategy crippled both the short- and long-term prospects for Winn-Dixie. The company paid a high premium to expand and increased its leverage without ever realizing the purposed synergies. In fact, there were dis-economies of scale because the distribution, marketing, and administrative costs had risen along with the increased revenue. The expansion and inefficient manufacturing added complexity to its distribution network, and with a greater debt load and less cash, the company was unable to reposition itself in the market when its low-cost provider strategy failed. Not only was the company unable to pursue other opportunities but it also did not have the cash to properly maintain many of its existing stores, which quickly became run down. Winn-Dixie was stuck as a general grocer with few options at a time when the industry was rapidly evolving. Following faulty strategies of expansion, supply chain changes, and increased debt, Winn-Dixie declared bankruptcy. Students will take the view that Paul "Flip" Huffard, lead consultant from Blackstone LP, had in determining the valuation and new capital structure of the company. These decisions would be critical, as they affected what each creditor class would receive and whether Winn-Dixie could emerge from bankruptcy.

Case Authors : James Shein, Evan Meagher

Topic : Organizational Development

Related Areas : Costs, Crisis management, Entrepreneurial management, Financial analysis, Financial markets, Reorganization

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Calculating Net Present Value (NPV) at 6% for Winn-Dixie Stores in 2005 (B): Cleanup on Aisle 11 Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019185)	-10019185	-	-
Year 1	3469175	-6550010	3469175	0.9434	3272807
Year 2	3963622	-2586388	7432797	0.89	3527609
Year 3	3959856	1373468	11392653	0.8396	3324771
Year 4	3233013	4606481	14625666	0.7921	2560849
TOTAL			14625666		12686037

The Net Present Value at 6% discount rate is 2666852

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. Net Present Value
2. Internal Rate of Return
3. Payback Period
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. Dixie Winn 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 Dixie Winn have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Winn-Dixie Stores in 2005 (B): Cleanup on Aisle 11

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 Organizational Development 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 Dixie Winn 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 Dixie Winn 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	(10019185)	-10019185	-	-
Year 1	3469175	-6550010	3469175	0.8696	3016674
Year 2	3963622	-2586388	7432797	0.7561	2997068
Year 3	3959856	1373468	11392653	0.6575	2603670
Year 4	3233013	4606481	14625666	0.5718	1848486
TOTAL					10465897

The Net NPV after 4 years is 446712

(10465897 - 10019185 )

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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	(10019185)	-10019185	-	-
Year 1	3469175	-6550010	3469175	0.8333	2890979
Year 2	3963622	-2586388	7432797	0.6944	2752515
Year 3	3959856	1373468	11392653	0.5787	2291583
Year 4	3233013	4606481	14625666	0.4823	1559130
TOTAL					9494208

The Net NPV after 4 years is -524977

At 20% discount rate the NPV is negative (9494208 - 10019185 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Dixie Winn 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 Dixie Winn has a NPV value higher than Zero then finance managers at Dixie Winn 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 Dixie Winn, then the stock price of the Dixie Winn 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 Dixie Winn 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.

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.

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 Winn-Dixie Stores in 2005 (B): Cleanup on Aisle 11

References & Further Readings

James Shein, Evan Meagher (2018), "Winn-Dixie Stores in 2005 (B): Cleanup on Aisle 11 Harvard Business Review Case Study. Published by HBR Publications.