Catalina in the Digital Age 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 Catalina in the Digital Age case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Catalina in the Digital Age case study is a Harvard Business School (HBR) case study written by Robert J. Dolan, Uma R. Karmarkar. The Catalina in the Digital Age (referred as “Catalina Coupons” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Technology.

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 Catalina in the Digital Age Case Study

To maximize their effectiveness, color cases should be printed in color.Catalina in the Digital Age considers how a company with a dominant market position should evolve its established product lines given the rise of novel digital technologies. Since its founding in 1983, Catalina had enjoyed a distinct position in the world of consumer promotions. Serving both retailers and consumer packaged goods (CPG) firms, the company's core business was distributing "cents off" coupons to shoppers via proprietary printers at checkout registers. This position allowed them to offer coupons that were "personalized" to the purchases that had just been made in the current transaction. The advent of shopper loyalty cards in the 1990s allowed them to expand that targeting to take shopper's history of purchase into account as well. In many ways, they were a successful "big data" firm well before the term became an industry buzzword.

Case Authors : Robert J. Dolan, Uma R. Karmarkar

Topic : Sales & Marketing

Related Areas : Technology

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Calculating Net Present Value (NPV) at 6% for Catalina in the Digital Age Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10028108)	-10028108	-	-
Year 1	3445251	-6582857	3445251	0.9434	3250237
Year 2	3968212	-2614645	7413463	0.89	3531695
Year 3	3962729	1348084	11376192	0.8396	3327184
Year 4	3249468	4597552	14625660	0.7921	2573883
TOTAL			14625660		12682998

The Net Present Value at 6% discount rate is 2654890

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. Timing of the expected cash flows – stockholders of Catalina Coupons 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. Catalina Coupons shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Catalina in the Digital Age

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 Catalina Coupons 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 Catalina Coupons 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	(10028108)	-10028108	-	-
Year 1	3445251	-6582857	3445251	0.8696	2995870
Year 2	3968212	-2614645	7413463	0.7561	3000538
Year 3	3962729	1348084	11376192	0.6575	2605559
Year 4	3249468	4597552	14625660	0.5718	1857894
TOTAL					10459861

The Net NPV after 4 years is 431753

(10459861 - 10028108 )

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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	(10028108)	-10028108	-	-
Year 1	3445251	-6582857	3445251	0.8333	2871043
Year 2	3968212	-2614645	7413463	0.6944	2755703
Year 3	3962729	1348084	11376192	0.5787	2293246
Year 4	3249468	4597552	14625660	0.4823	1567066
TOTAL					9487057

The Net NPV after 4 years is -541051

At 20% discount rate the NPV is negative (9487057 - 10028108 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Catalina Coupons 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 Catalina Coupons has a NPV value higher than Zero then finance managers at Catalina Coupons 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 Catalina Coupons, then the stock price of the Catalina Coupons 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 Catalina Coupons 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 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.

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.

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 Catalina in the Digital Age

References & Further Readings

Robert J. Dolan, Uma R. Karmarkar (2018), "Catalina in the Digital Age Harvard Business Review Case Study. Published by HBR Publications.