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Spark Publishing and Printing House: Short-Run Managerial Decision Raises A 'Hamlet-Like' 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 Spark Publishing and Printing House: Short-Run Managerial Decision Raises A 'Hamlet-Like' Dilemma case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Spark Publishing and Printing House: Short-Run Managerial Decision Raises A 'Hamlet-Like' Dilemma case study is a Harvard Business School (HBR) case study written by Shruti Dave. The Spark Publishing and Printing House: Short-Run Managerial Decision Raises A 'Hamlet-Like' Dilemma (referred as “Printing Publishing” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Costs.

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 Spark Publishing and Printing House: Short-Run Managerial Decision Raises A 'Hamlet-Like' Dilemma Case Study


Spark Publishing and Printing House is a comprehensive case on relevant costs analysis for short run alternative choice decisions. It stresses the importance of future differential cash flow analysis and highlights the irrelevance of past and non differential costs for managerial decisions. SPPH is a reputed publishing and printing house. It has two departments: Publishing and Printing and Distribution. SPPH has received a proposal from Fine Printing Press to take up its printing and distribution work for initial period of one year. The managerial decision involved is whether to outsource or to maintain status quo. Relevant cost analysis is to be used to determine which alternative is cost effective.


Case Authors : Shruti Dave

Topic : Finance & Accounting

Related Areas : Costs




Calculating Net Present Value (NPV) at 6% for Spark Publishing and Printing House: Short-Run Managerial Decision Raises A 'Hamlet-Like' Dilemma Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10013160) -10013160 - -
Year 1 3453494 -6559666 3453494 0.9434 3258013
Year 2 3969239 -2590427 7422733 0.89 3532609
Year 3 3948972 1358545 11371705 0.8396 3315633
Year 4 3229486 4588031 14601191 0.7921 2558055
TOTAL 14601191 12664310


The Net Present Value at 6% discount rate is 2651150

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. Profitability Index
2. Payback Period
3. Internal Rate of Return
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 Printing Publishing 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. Printing Publishing shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.




Formula and Steps to Calculate Net Present Value (NPV) of Spark Publishing and Printing House: Short-Run Managerial Decision Raises A 'Hamlet-Like' 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 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 Printing Publishing 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 Printing Publishing 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 (10013160) -10013160 - -
Year 1 3453494 -6559666 3453494 0.8696 3003038
Year 2 3969239 -2590427 7422733 0.7561 3001315
Year 3 3948972 1358545 11371705 0.6575 2596513
Year 4 3229486 4588031 14601191 0.5718 1846469
TOTAL 10447335


The Net NPV after 4 years is 434175

(10447335 - 10013160 )






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 (10013160) -10013160 - -
Year 1 3453494 -6559666 3453494 0.8333 2877912
Year 2 3969239 -2590427 7422733 0.6944 2756416
Year 3 3948972 1358545 11371705 0.5787 2285285
Year 4 3229486 4588031 14601191 0.4823 1557430
TOTAL 9477042


The Net NPV after 4 years is -536118

At 20% discount rate the NPV is negative (9477042 - 10013160 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Printing Publishing 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 Printing Publishing has a NPV value higher than Zero then finance managers at Printing Publishing 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 Printing Publishing, then the stock price of the Printing Publishing 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 Printing Publishing 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 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 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.

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

Shruti Dave (2018), "Spark Publishing and Printing House: Short-Run Managerial Decision Raises A 'Hamlet-Like' Dilemma Harvard Business Review Case Study. Published by HBR Publications.