By-the-Sea Biscuit Company: A Decision in New Venture Analysis 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 By-the-Sea Biscuit Company: A Decision in New Venture Analysis case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. By-the-Sea Biscuit Company: A Decision in New Venture Analysis case study is a Harvard Business School (HBR) case study written by Sherry Finney. The By-the-Sea Biscuit Company: A Decision in New Venture Analysis (referred as “Finney Jobe” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Entrepreneurship, Financial analysis, Marketing.

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 By-the-Sea Biscuit Company: A Decision in New Venture Analysis Case Study

Paul Finney and Pat Jobe, long-time friends and future business partners, are proposing the establishment of a frozen biscuit manufacturing operation in the now defunct Clearwater Seafood plant in North Sydney, Nova Scotia. Cape Breton Innovation and Research Council (CBIRC), a private corporation, had recently assumed ownership of the plant and wanted to expand and develop local business by creating an incubator within the facility. Finney and Jobe presented a business proposal to CBIRC in August 2006 and the organization was very excited and believed the idea had promise. Finney and Jobe, although convinced of the merits of the product concept, still had some questions that needed answering before they could make a final assessment on the feasibility of the business. Both were employed full-time and the decision to leave their jobs to pursue this business was not a decision that could be made lightly. The case includes detail on the market structure and demand within the bakery/frozen dough industry. Additionally, the proposed marketing mix, selected target markets, and production/operation plans are covered in depth. Finney and Jobe now need to sift through the information and make a decision on the market size and sales potential for By-the-Sea Biscuit Company. The immediate task facing Finney and Jobe is to determine the sales potential for By-the-Sea Biscuit Company. Based on the projected sales and expenses, the partners must also make an assessment on the feasibility of the business.

Case Authors : Sherry Finney

Topic : Sales & Marketing

Related Areas : Entrepreneurship, Financial analysis, Marketing

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Calculating Net Present Value (NPV) at 6% for By-the-Sea Biscuit Company: A Decision in New Venture Analysis Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10006439)	-10006439	-	-
Year 1	3463683	-6542756	3463683	0.9434	3267625
Year 2	3970190	-2572566	7433873	0.89	3533455
Year 3	3943937	1371371	11377810	0.8396	3311406
Year 4	3222847	4594218	14600657	0.7921	2552797
TOTAL			14600657		12665283

The Net Present Value at 6% discount rate is 2658844

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. Net Present Value
2. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Finney Jobe 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 Finney Jobe have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of By-the-Sea Biscuit Company: A Decision in New Venture Analysis

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 Finney Jobe 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 Finney Jobe 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	(10006439)	-10006439	-	-
Year 1	3463683	-6542756	3463683	0.8696	3011898
Year 2	3970190	-2572566	7433873	0.7561	3002034
Year 3	3943937	1371371	11377810	0.6575	2593203
Year 4	3222847	4594218	14600657	0.5718	1842673
TOTAL					10449808

The Net NPV after 4 years is 443369

(10449808 - 10006439 )

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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	(10006439)	-10006439	-	-
Year 1	3463683	-6542756	3463683	0.8333	2886403
Year 2	3970190	-2572566	7433873	0.6944	2757076
Year 3	3943937	1371371	11377810	0.5787	2282371
Year 4	3222847	4594218	14600657	0.4823	1554228
TOTAL					9480078

The Net NPV after 4 years is -526361

At 20% discount rate the NPV is negative (9480078 - 10006439 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Finney Jobe 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 Finney Jobe has a NPV value higher than Zero then finance managers at Finney Jobe 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 Finney Jobe, then the stock price of the Finney Jobe 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 Finney Jobe 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 can impact the cash flow of the project.

Understanding of risks involved in the project.

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

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.

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 By-the-Sea Biscuit Company: A Decision in New Venture Analysis

References & Further Readings

Sherry Finney (2018), "By-the-Sea Biscuit Company: A Decision in New Venture Analysis Harvard Business Review Case Study. Published by HBR Publications.