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Kering: Luxury in the Digital World? 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 Kering: Luxury in the Digital World? case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Kering: Luxury in the Digital World? case study is a Harvard Business School (HBR) case study written by Marta Jarosinski, June Cotte. The Kering: Luxury in the Digital World? (referred as “Kering Luxury” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Strategy.

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 Kering: Luxury in the Digital World? Case Study


Since 2005, the chief executive officer of Kering, a conglomerate headquartered in Paris, has successfully streamlined the company's business strategy to concentrate on luxury goods and sporting and lifestyle brands -including Gucci, Yves St-Laurent, Stella McCartney, Alexander McQueen and Balenciaga, among others - through selling off non-related businesses. By 2012, the company was more focused than ever before but was sluggish in one key aspect - its online presence. Like most competitors within the luxury industry, it was struggling with how it should capitalize on the benefits of a web presence, trying not to stray away from the luxury strategy of its brands. Kering recognized the importance of growing online, but needed to come up with an ideal approach to successfully grow the digital presence of its luxury brands.


Case Authors : Marta Jarosinski, June Cotte

Topic : Sales & Marketing

Related Areas : Strategy




Calculating Net Present Value (NPV) at 6% for Kering: Luxury in the Digital World? Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10002326) -10002326 - -
Year 1 3472542 -6529784 3472542 0.9434 3275983
Year 2 3966372 -2563412 7438914 0.89 3530057
Year 3 3971420 1408008 11410334 0.8396 3334481
Year 4 3245920 4653928 14656254 0.7921 2571073
TOTAL 14656254 12711593


The Net Present Value at 6% discount rate is 2709267

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. Payback Period
2. Internal Rate of Return
3. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Kering Luxury 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 Kering Luxury have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.




Formula and Steps to Calculate Net Present Value (NPV) of Kering: Luxury in the Digital World?

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 Kering Luxury 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 Kering Luxury 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 (10002326) -10002326 - -
Year 1 3472542 -6529784 3472542 0.8696 3019602
Year 2 3966372 -2563412 7438914 0.7561 2999147
Year 3 3971420 1408008 11410334 0.6575 2611273
Year 4 3245920 4653928 14656254 0.5718 1855865
TOTAL 10485887


The Net NPV after 4 years is 483561

(10485887 - 10002326 )






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 (10002326) -10002326 - -
Year 1 3472542 -6529784 3472542 0.8333 2893785
Year 2 3966372 -2563412 7438914 0.6944 2754425
Year 3 3971420 1408008 11410334 0.5787 2298275
Year 4 3245920 4653928 14656254 0.4823 1565355
TOTAL 9511840


The Net NPV after 4 years is -490486

At 20% discount rate the NPV is negative (9511840 - 10002326 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Kering Luxury 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 Kering Luxury has a NPV value higher than Zero then finance managers at Kering Luxury 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 Kering Luxury, then the stock price of the Kering Luxury 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 Kering Luxury 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 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.

Understanding of risks involved in 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 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.




References & Further Readings

Marta Jarosinski, June Cotte (2018), "Kering: Luxury in the Digital World? Harvard Business Review Case Study. Published by HBR Publications.