Millway Fabrics Canada 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 Millway Fabrics Canada case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Millway Fabrics Canada case study is a Harvard Business School (HBR) case study written by James A. Erskine, Erin Donovan. The Millway Fabrics Canada (referred as “Agent Millway” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Human resource management, Work-life balance.

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 Millway Fabrics Canada Case Study

The director of operations for Millway Fabrics Canada walked into her office and one of the customer service agents was waiting for her in tears. The customer service agent (agent) needed a week off to take care of her son who was about to have surgery to have his tonsils removed. The agent had already taken all her vacation and sick time due to her son's illness. The agent was a strong performer and was well-liked by her co-workers. The director of operations had to make a decision.

Case Authors : James A. Erskine, Erin Donovan

Topic : Organizational Development

Related Areas : Human resource management, Work-life balance

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Calculating Net Present Value (NPV) at 6% for Millway Fabrics Canada Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10013963)	-10013963	-	-
Year 1	3444953	-6569010	3444953	0.9434	3249956
Year 2	3974040	-2594970	7418993	0.89	3536881
Year 3	3970886	1375916	11389879	0.8396	3334032
Year 4	3245891	4621807	14635770	0.7921	2571050
TOTAL			14635770		12691919

The Net Present Value at 6% discount rate is 2677956

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. Profitability Index
2. Payback Period
3. Internal Rate of Return
4. Net Present Value

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 Agent Millway 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. Agent Millway 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 Millway Fabrics Canada

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 Agent Millway 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 Agent Millway 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	(10013963)	-10013963	-	-
Year 1	3444953	-6569010	3444953	0.8696	2995611
Year 2	3974040	-2594970	7418993	0.7561	3004945
Year 3	3970886	1375916	11389879	0.6575	2610922
Year 4	3245891	4621807	14635770	0.5718	1855849
TOTAL					10467327

The Net NPV after 4 years is 453364

(10467327 - 10013963 )

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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	(10013963)	-10013963	-	-
Year 1	3444953	-6569010	3444953	0.8333	2870794
Year 2	3974040	-2594970	7418993	0.6944	2759750
Year 3	3970886	1375916	11389879	0.5787	2297966
Year 4	3245891	4621807	14635770	0.4823	1565341
TOTAL					9493852

The Net NPV after 4 years is -520111

At 20% discount rate the NPV is negative (9493852 - 10013963 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Agent Millway 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 Agent Millway has a NPV value higher than Zero then finance managers at Agent Millway 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 Agent Millway, then the stock price of the Agent Millway 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 Agent Millway 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 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.

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 Millway Fabrics Canada

References & Further Readings

James A. Erskine, Erin Donovan (2018), "Millway Fabrics Canada Harvard Business Review Case Study. Published by HBR Publications.