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Ledals Redistributor: Enacting Policies that Frustrate Salespeople and Customers 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 Ledals Redistributor: Enacting Policies that Frustrate Salespeople and Customers case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Ledals Redistributor: Enacting Policies that Frustrate Salespeople and Customers case study is a Harvard Business School (HBR) case study written by William H. Murphy. The Ledals Redistributor: Enacting Policies that Frustrate Salespeople and Customers (referred as “Ledals Salespeople” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Pricing.

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 Ledals Redistributor: Enacting Policies that Frustrate Salespeople and Customers Case Study


Ledals, one of the premier redistribution firms in the United States, had determined that whenever backorders occurred, the additional trips being made by delivery trucks were killing margins. Therefore, management imposed a new policy, whereby backordered items would be held until the next customer order was received and prepared for shipping.This arrangement led to repercussions, with both customers and Ledals' salespeople frustrated with the new policy. Muted at first, but growing in volume, many members of the sales force were clearly disgruntled. What remained was figuring out how much damage was actually being done. Was it simply a predictable resistance to change that would resolve itself in the coming months? If it was a genuine problem, Ledals' management needed to consider what, if any, actions should be taken. Ledals also had to determine whether the problem was with the policy itself or its implementation. Regardless of the cause, management had to make a decision as soon as possible about how to move forward. William H. Murphy is affiliated with University of Saskatchewan.


Case Authors : William H. Murphy

Topic : Sales & Marketing

Related Areas : Pricing




Calculating Net Present Value (NPV) at 6% for Ledals Redistributor: Enacting Policies that Frustrate Salespeople and Customers Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10016466) -10016466 - -
Year 1 3465958 -6550508 3465958 0.9434 3269772
Year 2 3982298 -2568210 7448256 0.89 3544231
Year 3 3942040 1373830 11390296 0.8396 3309813
Year 4 3222689 4596519 14612985 0.7921 2552672
TOTAL 14612985 12676487




The Net Present Value at 6% discount rate is 2660021

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. Profitability Index
3. Payback Period
4. Internal Rate of Return

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 Ledals Salespeople 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. Ledals Salespeople 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 Ledals Redistributor: Enacting Policies that Frustrate Salespeople and Customers

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 Ledals Salespeople 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 Ledals Salespeople 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 (10016466) -10016466 - -
Year 1 3465958 -6550508 3465958 0.8696 3013877
Year 2 3982298 -2568210 7448256 0.7561 3011189
Year 3 3942040 1373830 11390296 0.6575 2591955
Year 4 3222689 4596519 14612985 0.5718 1842583
TOTAL 10459604


The Net NPV after 4 years is 443138

(10459604 - 10016466 )








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 (10016466) -10016466 - -
Year 1 3465958 -6550508 3465958 0.8333 2888298
Year 2 3982298 -2568210 7448256 0.6944 2765485
Year 3 3942040 1373830 11390296 0.5787 2281273
Year 4 3222689 4596519 14612985 0.4823 1554152
TOTAL 9489208


The Net NPV after 4 years is -527258

At 20% discount rate the NPV is negative (9489208 - 10016466 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ledals Salespeople 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 Ledals Salespeople has a NPV value higher than Zero then finance managers at Ledals Salespeople 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 Ledals Salespeople, then the stock price of the Ledals Salespeople 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 Ledals Salespeople 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 can impact the cash flow of the project.

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

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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.






Negotiation Strategy of Ledals Redistributor: Enacting Policies that Frustrate Salespeople and Customers

References & Further Readings

William H. Murphy (2018), "Ledals Redistributor: Enacting Policies that Frustrate Salespeople and Customers Harvard Business Review Case Study. Published by HBR Publications.


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