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NPV: Filene's Basement: Inside a Fired Customer's Relationship Net Present Value Case Analysis
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Filene's Basement: Inside a Fired Customer's Relationship 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 Filene's Basement: Inside a Fired Customer's Relationship case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Filene's Basement: Inside a Fired Customer's Relationship case study is a Harvard Business School (HBR) case study written by Jill Avery, Susan Fournier. The Filene's Basement: Inside a Fired Customer's Relationship (referred as “Basement Filene's” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, 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




Case Description of Filene's Basement: Inside a Fired Customer's Relationship Case Study


How, in a business climate in which building relationships with customers has dominated both managerial thought and marketing budgets, could Filene's Basement have fired a loyal customer, one who was formally and informally recognized as a best customer? This case allows students to reverse-engineer a fired customer's relationship with discount retailer Filene's Basement, from her perspective, to uncover the critical incidents and behaviors of each party that shaped their relationship trajectory. The company's customer relationship management (CRM) programs are analyzed to show how they influenced and encouraged unprofitable customer behavior.


Case Authors : Jill Avery, Susan Fournier

Topic : Sales & Marketing

Related Areas : Strategy




Calculating Net Present Value (NPV) at 6% for Filene's Basement: Inside a Fired Customer's Relationship Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10012332) -10012332 - -
Year 1 3459819 -6552513 3459819 0.9434 3263980
Year 2 3958065 -2594448 7417884 0.89 3522664
Year 3 3939430 1344982 11357314 0.8396 3307621
Year 4 3250040 4595022 14607354 0.7921 2574336
TOTAL 14607354 12668601


The Net Present Value at 6% discount rate is 2656269

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.




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. Payback Period
3. Internal Rate of Return
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. Basement Filene's 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 Basement Filene's have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.




Formula and Steps to Calculate Net Present Value (NPV) of Filene's Basement: Inside a Fired Customer's Relationship

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 Basement Filene's 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 Basement Filene's 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 (10012332) -10012332 - -
Year 1 3459819 -6552513 3459819 0.8696 3008538
Year 2 3958065 -2594448 7417884 0.7561 2992866
Year 3 3939430 1344982 11357314 0.6575 2590239
Year 4 3250040 4595022 14607354 0.5718 1858221
TOTAL 10449864


The Net NPV after 4 years is 437532

(10449864 - 10012332 )






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 (10012332) -10012332 - -
Year 1 3459819 -6552513 3459819 0.8333 2883183
Year 2 3958065 -2594448 7417884 0.6944 2748656
Year 3 3939430 1344982 11357314 0.5787 2279763
Year 4 3250040 4595022 14607354 0.4823 1567342
TOTAL 9478943


The Net NPV after 4 years is -533389

At 20% discount rate the NPV is negative (9478943 - 10012332 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Basement Filene's 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 Basement Filene's has a NPV value higher than Zero then finance managers at Basement Filene's 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 Basement Filene's, then the stock price of the Basement Filene's 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 Basement Filene's 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 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.

What can impact the cash flow of the project.

Understanding of risks involved in 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.

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.




References & Further Readings

Jill Avery, Susan Fournier (2018), "Filene's Basement: Inside a Fired Customer's Relationship Harvard Business Review Case Study. Published by HBR Publications.