The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms 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 The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms case study is a Harvard Business School (HBR) case study written by Marta K Dowejko, Gilbert Wong. The The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms (referred as “Coffee Bolaven” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Entrepreneurial management, Growth strategy, Influence, International business, Social enterprise, Supply chain.

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 The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms Case Study

Founded in 2007, Bolaven Farms is a coffee business with a social purpose. Set up in Laos and Hong Kong, Bolaven Farms aims at providing high-quality coffee to the worldwide public while helping to alleviate poverty among coffee farmers in Laos. The business model involves a full integration of the coffee supply chain, from planting the coffee seed to selling the final branded product to wholesale and retail customers. Consequently, farmers and the company benefit from excluding intermediaries from the supply chain and keeping profit margins for themselves. The company's vision of educating farmers and providing them with higher income for their work is very compelling to the public and was quickly picked up by the media. However, the business model has yet to be tested. For one thing, once the farmers graduate from the programme, they need employment assurance and additional land to cultivate. For another, the coffee market is a mature one, with many players and a multitude of competing and lower-priced offers to choose from. People find the company's vision very inspiring, but it is also very difficult to translate into viable actions. The company has already invested US$4.0 million in the project, but is still a long way from educating the public and finding customers willing to pay premium prices for the coffee. Both ends of the supply chain need further refinement, and Say is not willing to compromise on quality or price. The case begins with an introduction of the coffee industry and its practices. A description of Laos as a business environment for Bolaven Farms follows. The case describes the development and implementation of a business model that incorporates vertical integration supported by social networks. It allows for an advanced analysis of issues related to choosing an appropriate business model and focuses on the risks related to future expansion and resulting from the strategic choices of the entrepreneur.

Case Authors : Marta K Dowejko, Gilbert Wong

Topic : Organizational Development

Related Areas : Entrepreneurial management, Growth strategy, Influence, International business, Social enterprise, Supply chain

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Calculating Net Present Value (NPV) at 6% for The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016747)	-10016747	-	-
Year 1	3460376	-6556371	3460376	0.9434	3264506
Year 2	3976099	-2580272	7436475	0.89	3538714
Year 3	3964362	1384090	11400837	0.8396	3328555
Year 4	3238163	4622253	14639000	0.7921	2564928
TOTAL			14639000		12696703

The Net Present Value at 6% discount rate is 2679956

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. Internal Rate of Return
2. Net Present Value
3. Profitability Index
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. Timing of the expected cash flows – stockholders of Coffee Bolaven 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. Coffee Bolaven 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 The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms

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 Coffee Bolaven 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 Coffee Bolaven 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	(10016747)	-10016747	-	-
Year 1	3460376	-6556371	3460376	0.8696	3009023
Year 2	3976099	-2580272	7436475	0.7561	3006502
Year 3	3964362	1384090	11400837	0.6575	2606632
Year 4	3238163	4622253	14639000	0.5718	1851430
TOTAL					10473587

The Net NPV after 4 years is 456840

(10473587 - 10016747 )

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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	(10016747)	-10016747	-	-
Year 1	3460376	-6556371	3460376	0.8333	2883647
Year 2	3976099	-2580272	7436475	0.6944	2761180
Year 3	3964362	1384090	11400837	0.5787	2294191
Year 4	3238163	4622253	14639000	0.4823	1561614
TOTAL					9500632

The Net NPV after 4 years is -516115

At 20% discount rate the NPV is negative (9500632 - 10016747 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Coffee Bolaven 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 Coffee Bolaven has a NPV value higher than Zero then finance managers at Coffee Bolaven 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 Coffee Bolaven, then the stock price of the Coffee Bolaven 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 Coffee Bolaven 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 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.

What can impact the cash flow of 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 The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms

References & Further Readings

Marta K Dowejko, Gilbert Wong (2018), "The Lao Coffee Industry: Implementing Vertical Integration for a Social Cause at Bolaven Farms Harvard Business Review Case Study. Published by HBR Publications.