Graham's Pharmacy: Traditional Care, Modern Solutions 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 Graham's Pharmacy: Traditional Care, Modern Solutions case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Graham's Pharmacy: Traditional Care, Modern Solutions case study is a Harvard Business School (HBR) case study written by Nicole Berube, R. Frank Delanghe. The Graham's Pharmacy: Traditional Care, Modern Solutions (referred as “Pharmacy Graham's” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, .

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 Graham's Pharmacy: Traditional Care, Modern Solutions Case Study

In 2012, Graham's Pharmacy opened to offer more traditional pharmacy services and counselling in contrast to franchise pharmacies. The business was the brainchild of a pharmacist and entrepreneur with a strong commitment to the pharmacist profession. Located in the heart of the historic business sector of Kingston, Ontario, Graham's Pharmacy had taken over a historic building that formerly housed a bank. The pharmacy was intended to improve the quality of life of its clients through prevention and active engagement, rather than merely through the passive and mundane role of a pill dispensary. However, the pharmacy needed to be profitable if the vision was to be fully realized. Although the founder was confident in the capabilities of his team, and that a market existed for a pharmacy that provided personalized service and advice, he wondered how to market the business in light of competition from much larger rivals. Nicole BA?rubA? is affiliated with Royal Military College of Canada.

Case Authors : Nicole Berube, R. Frank Delanghe

Topic : Sales & Marketing

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Graham's Pharmacy: Traditional Care, Modern Solutions Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10007950)	-10007950	-	-
Year 1	3458207	-6549743	3458207	0.9434	3262459
Year 2	3981961	-2567782	7440168	0.89	3543931
Year 3	3973157	1405375	11413325	0.8396	3335939
Year 4	3229137	4634512	14642462	0.7921	2557779
TOTAL			14642462		12700109

The Net Present Value at 6% discount rate is 2692159

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. Payback Period
3. Profitability Index
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 Pharmacy Graham's 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. Pharmacy Graham's 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 Graham's Pharmacy: Traditional Care, Modern Solutions

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 Pharmacy Graham's 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 Pharmacy Graham's 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	(10007950)	-10007950	-	-
Year 1	3458207	-6549743	3458207	0.8696	3007137
Year 2	3981961	-2567782	7440168	0.7561	3010935
Year 3	3973157	1405375	11413325	0.6575	2612415
Year 4	3229137	4634512	14642462	0.5718	1846270
TOTAL					10476756

The Net NPV after 4 years is 468806

(10476756 - 10007950 )

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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	(10007950)	-10007950	-	-
Year 1	3458207	-6549743	3458207	0.8333	2881839
Year 2	3981961	-2567782	7440168	0.6944	2765251
Year 3	3973157	1405375	11413325	0.5787	2299281
Year 4	3229137	4634512	14642462	0.4823	1557261
TOTAL					9503632

The Net NPV after 4 years is -504318

At 20% discount rate the NPV is negative (9503632 - 10007950 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Pharmacy Graham's 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 Pharmacy Graham's has a NPV value higher than Zero then finance managers at Pharmacy Graham's 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 Pharmacy Graham's, then the stock price of the Pharmacy Graham's 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 Pharmacy Graham's 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 will be a multi year spillover effect of various taxation regulations.

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.

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 Graham's Pharmacy: Traditional Care, Modern Solutions

References & Further Readings

Nicole Berube, R. Frank Delanghe (2018), "Graham's Pharmacy: Traditional Care, Modern Solutions Harvard Business Review Case Study. Published by HBR Publications.