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Costa Poulopoulos and Mary Johnson - Realtors 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 Costa Poulopoulos and Mary Johnson - Realtors case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Costa Poulopoulos and Mary Johnson - Realtors case study is a Harvard Business School (HBR) case study written by Elizabeth M.A. Grasby, Niki Healey. The Costa Poulopoulos and Mary Johnson - Realtors (referred as “Poulopoulos Realtors” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, .

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 Costa Poulopoulos and Mary Johnson - Realtors Case Study


A partnership of two real estate agents want to increase their recognition in an increasingly crowded and competitive marketplace. Both partners had strong individual reputations, but they believed a campaign focused on their identity as a team would give them a competitive edge in the real estate business. A comprehensive marketing communications plan needed to be developed and implemented quickly as the market was poised for a period of growth in the coming months.


Case Authors : Elizabeth M.A. Grasby, Niki Healey

Topic : Sales & Marketing

Related Areas :




Calculating Net Present Value (NPV) at 6% for Costa Poulopoulos and Mary Johnson - Realtors Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10017149) -10017149 - -
Year 1 3457731 -6559418 3457731 0.9434 3262010
Year 2 3981347 -2578071 7439078 0.89 3543385
Year 3 3975311 1397240 11414389 0.8396 3337748
Year 4 3246631 4643871 14661020 0.7921 2571636
TOTAL 14661020 12714779


The Net Present Value at 6% discount rate is 2697630

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. Internal Rate of Return
2. Payback Period
3. Net Present Value
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. Poulopoulos Realtors 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 Poulopoulos Realtors 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 Costa Poulopoulos and Mary Johnson - Realtors

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 Poulopoulos Realtors 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 Poulopoulos Realtors 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 (10017149) -10017149 - -
Year 1 3457731 -6559418 3457731 0.8696 3006723
Year 2 3981347 -2578071 7439078 0.7561 3010470
Year 3 3975311 1397240 11414389 0.6575 2613832
Year 4 3246631 4643871 14661020 0.5718 1856272
TOTAL 10487296


The Net NPV after 4 years is 470147

(10487296 - 10017149 )






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 (10017149) -10017149 - -
Year 1 3457731 -6559418 3457731 0.8333 2881443
Year 2 3981347 -2578071 7439078 0.6944 2764824
Year 3 3975311 1397240 11414389 0.5787 2300527
Year 4 3246631 4643871 14661020 0.4823 1565698
TOTAL 9512492


The Net NPV after 4 years is -504657

At 20% discount rate the NPV is negative (9512492 - 10017149 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Poulopoulos Realtors 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 Poulopoulos Realtors has a NPV value higher than Zero then finance managers at Poulopoulos Realtors 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 Poulopoulos Realtors, then the stock price of the Poulopoulos Realtors 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 Poulopoulos Realtors 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 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.

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

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

Elizabeth M.A. Grasby, Niki Healey (2018), "Costa Poulopoulos and Mary Johnson - Realtors Harvard Business Review Case Study. Published by HBR Publications.