Litehouse Foods: The Glass Dilemma 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 Litehouse Foods: The Glass Dilemma case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Litehouse Foods: The Glass Dilemma case study is a Harvard Business School (HBR) case study written by John J. Lawrence, Anubha Mishra, Marie Pengilly. The Litehouse Foods: The Glass Dilemma (referred as “Litehouse Glass” 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, Supply chain, Sustainability.

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 Litehouse Foods: The Glass Dilemma Case Study

This case focuses on whether Litehouse Foods should switch its signature creamy salad dressings from glass to plastic packaging. The central figure in the case is Doug Hawkins Jr., the company's Senior Business Development Manager (Marketing lead). The company, which is one of three major players nationally in the refrigerated salad dressing market, has been selling its dressings in glass jars for 50 years, and these glass jars are considered an important element in how consumers think about the Litehouse brand. Two of Litehouse Foods' competitors have recently switched to plastic, however, and this has helped them achieve a significant price advantage over Litehouse at retail. Switching to plastic jars would save Litehouse $1.5 million/year and allow it to narrow the price advantage opened up by competitors. Doug must develop a recommendation to the company's executive committee that considers the cost savings potential of plastic against the value of the glass packaging to the brand. Complicating this decision are the environmental implications of a switch from glass to plastic, both real and perceived, as well as how a change at this time would mesh with the company's recently launched growth strategy.

Case Authors : John J. Lawrence, Anubha Mishra, Marie Pengilly

Topic : Sales & Marketing

Related Areas : Customers, Supply chain, Sustainability

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Calculating Net Present Value (NPV) at 6% for Litehouse Foods: The Glass Dilemma Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019051)	-10019051	-	-
Year 1	3450624	-6568427	3450624	0.9434	3255306
Year 2	3969228	-2599199	7419852	0.89	3532599
Year 3	3970921	1371722	11390773	0.8396	3334062
Year 4	3244406	4616128	14635179	0.7921	2569873
TOTAL			14635179		12691840

The Net Present Value at 6% discount rate is 2672789

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. 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. Litehouse Glass 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 Litehouse Glass 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 Litehouse Foods: The Glass Dilemma

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 Litehouse Glass 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 Litehouse Glass 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	(10019051)	-10019051	-	-
Year 1	3450624	-6568427	3450624	0.8696	3000543
Year 2	3969228	-2599199	7419852	0.7561	3001307
Year 3	3970921	1371722	11390773	0.6575	2610945
Year 4	3244406	4616128	14635179	0.5718	1855000
TOTAL					10467794

The Net NPV after 4 years is 448743

(10467794 - 10019051 )

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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	(10019051)	-10019051	-	-
Year 1	3450624	-6568427	3450624	0.8333	2875520
Year 2	3969228	-2599199	7419852	0.6944	2756408
Year 3	3970921	1371722	11390773	0.5787	2297987
Year 4	3244406	4616128	14635179	0.4823	1564625
TOTAL					9494540

The Net NPV after 4 years is -524511

At 20% discount rate the NPV is negative (9494540 - 10019051 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Litehouse Glass 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 Litehouse Glass has a NPV value higher than Zero then finance managers at Litehouse Glass 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 Litehouse Glass, then the stock price of the Litehouse Glass 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 Litehouse Glass 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 –

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.

What can impact the cash flow of 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 Litehouse Foods: The Glass Dilemma

References & Further Readings

John J. Lawrence, Anubha Mishra, Marie Pengilly (2018), "Litehouse Foods: The Glass Dilemma Harvard Business Review Case Study. Published by HBR Publications.