Jinwoong: Financing an Entrepreneurial Firm in the Wake of the Korean Financial Crisis 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 Jinwoong: Financing an Entrepreneurial Firm in the Wake of the Korean Financial Crisis case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Jinwoong: Financing an Entrepreneurial Firm in the Wake of the Korean Financial Crisis case study is a Harvard Business School (HBR) case study written by Walter Kuemmerle, James Lee, Bokeun Jin. The Jinwoong: Financing an Entrepreneurial Firm in the Wake of the Korean Financial Crisis (referred as “Jinwoong Korean” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Emerging markets, Entrepreneurial finance, Financial management, Globalization, Growth strategy, Recession, 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 Jinwoong: Financing an Entrepreneurial Firm in the Wake of the Korean Financial Crisis Case Study

Describes T.P. Lee, the founder and CEO of Jinwoong, a 19-year-old entrepreneurial company in Korea that has grown to become the world's largest manufacturer of camping tents. Labeled by Fortune as one of the most promising entrepreneurs in Asia in 1993, Lee faces some serious management challenges by October 1998. Largely due to the Korean financial crisis of 1997-98, Lee must rethink the financing and expansion plans for his firm. To deal with these challenges, he could seek outside funding from two different groups of private equity investors or from a corporate restructuring fund set up by the Korean government. All of these decisions reflect Jinwoong's long-term strategy and Lee's assessment of the different offers.

Case Authors : Walter Kuemmerle, James Lee, Bokeun Jin

Topic : Finance & Accounting

Related Areas : Emerging markets, Entrepreneurial finance, Financial management, Globalization, Growth strategy, Recession, Reorganization

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Calculating Net Present Value (NPV) at 6% for Jinwoong: Financing an Entrepreneurial Firm in the Wake of the Korean Financial Crisis Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10026032)	-10026032	-	-
Year 1	3469148	-6556884	3469148	0.9434	3272781
Year 2	3968548	-2588336	7437696	0.89	3531994
Year 3	3964329	1375993	11402025	0.8396	3328527
Year 4	3227189	4603182	14629214	0.7921	2556236
TOTAL			14629214		12689538

The Net Present Value at 6% discount rate is 2663506

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. Profitability Index
3. Payback Period
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 Jinwoong Korean 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. Jinwoong Korean 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 Jinwoong: Financing an Entrepreneurial Firm in the Wake of the Korean Financial Crisis

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 Finance & Accounting 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 Jinwoong Korean 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 Jinwoong Korean 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	(10026032)	-10026032	-	-
Year 1	3469148	-6556884	3469148	0.8696	3016650
Year 2	3968548	-2588336	7437696	0.7561	3000792
Year 3	3964329	1375993	11402025	0.6575	2606611
Year 4	3227189	4603182	14629214	0.5718	1845156
TOTAL					10469209

The Net NPV after 4 years is 443177

(10469209 - 10026032 )

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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	(10026032)	-10026032	-	-
Year 1	3469148	-6556884	3469148	0.8333	2890957
Year 2	3968548	-2588336	7437696	0.6944	2755936
Year 3	3964329	1375993	11402025	0.5787	2294172
Year 4	3227189	4603182	14629214	0.4823	1556322
TOTAL					9497387

The Net NPV after 4 years is -528645

At 20% discount rate the NPV is negative (9497387 - 10026032 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Jinwoong Korean 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 Jinwoong Korean has a NPV value higher than Zero then finance managers at Jinwoong Korean 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 Jinwoong Korean, then the stock price of the Jinwoong Korean 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 Jinwoong Korean 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 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.

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 Jinwoong: Financing an Entrepreneurial Firm in the Wake of the Korean Financial Crisis

References & Further Readings

Walter Kuemmerle, James Lee, Bokeun Jin (2018), "Jinwoong: Financing an Entrepreneurial Firm in the Wake of the Korean Financial Crisis Harvard Business Review Case Study. Published by HBR Publications.