Reed Supermarkets: A New Wave of Competitors 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 Reed Supermarkets: A New Wave of Competitors case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Reed Supermarkets: A New Wave of Competitors case study is a Harvard Business School (HBR) case study written by John A. Quelch, Carole Carlson. The Reed Supermarkets: A New Wave of Competitors (referred as “Stores Collins” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Customers, Growth strategy.

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 Reed Supermarkets: A New Wave of Competitors Case Study

Reed Supermarkets is a high-end supermarket chain with operations in several Midwestern states. Meredith Collins, vice president of marketing, visits stores located in Columbus, Ohio, an important region with the largest market and the greatest impact on revenue growth. She is concerned about increased competition from dollar stores and limited-assortment stores offering very low, appealing price points. Reed's market research shows that as a result of the economic downturn, customer loyalty is dwindling and consumers are willing to go to multiple stores to get the best deals. Collins must decide whether to change the current marketing and positioning plan in an effort to increase market share to meet challenging corporate targets. Her options include retreating from price competition and focusing on quality or embracing more private-label brands and competing more aggressively on price. She can also maintain the current positioning and appeal to customers looking for a quality shopping experience. The case contains an implicit quantitative assignment that instructors can emphasize to the degree they choose.

Case Authors : John A. Quelch, Carole Carlson

Topic : Sales & Marketing

Related Areas : Customers, Growth strategy

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Calculating Net Present Value (NPV) at 6% for Reed Supermarkets: A New Wave of Competitors Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10022360)	-10022360	-	-
Year 1	3444692	-6577668	3444692	0.9434	3249709
Year 2	3960537	-2617131	7405229	0.89	3524864
Year 3	3954648	1337517	11359877	0.8396	3320399
Year 4	3231946	4569463	14591823	0.7921	2560004
TOTAL			14591823		12654976

The Net Present Value at 6% discount rate is 2632616

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 Stores Collins 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. Stores Collins 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 Reed Supermarkets: A New Wave of Competitors

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 Sales & Marketing 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 Stores Collins 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 Stores Collins 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	(10022360)	-10022360	-	-
Year 1	3444692	-6577668	3444692	0.8696	2995384
Year 2	3960537	-2617131	7405229	0.7561	2994735
Year 3	3954648	1337517	11359877	0.6575	2600245
Year 4	3231946	4569463	14591823	0.5718	1847876
TOTAL					10438240

The Net NPV after 4 years is 415880

(10438240 - 10022360 )

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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	(10022360)	-10022360	-	-
Year 1	3444692	-6577668	3444692	0.8333	2870577
Year 2	3960537	-2617131	7405229	0.6944	2750373
Year 3	3954648	1337517	11359877	0.5787	2288569
Year 4	3231946	4569463	14591823	0.4823	1558616
TOTAL					9468135

The Net NPV after 4 years is -554225

At 20% discount rate the NPV is negative (9468135 - 10022360 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Stores Collins 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 Stores Collins has a NPV value higher than Zero then finance managers at Stores Collins 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 Stores Collins, then the stock price of the Stores Collins 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 Stores Collins 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 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.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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 Reed Supermarkets: A New Wave of Competitors

References & Further Readings

John A. Quelch, Carole Carlson (2018), "Reed Supermarkets: A New Wave of Competitors Harvard Business Review Case Study. Published by HBR Publications.