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Vegpro Group: Growing in Harmony, Spanish Version 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 Vegpro Group: Growing in Harmony, Spanish Version case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Vegpro Group: Growing in Harmony, Spanish Version case study is a Harvard Business School (HBR) case study written by David E. Bell, Brian Milder, Mary L. Shelman. The Vegpro Group: Growing in Harmony, Spanish Version (referred as “Vegpro Food” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Emerging markets, Ethics, Growth strategy, Operations management, Regulation, Sustainability.

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 Vegpro Group: Growing in Harmony, Spanish Version Case Study


Vegpro, a horticulture company, is Kenya's largest exporter of fresh vegetables and flowers to top supermarkets in the U.K. and Europe. In 2007, Vegpro's business is threatened by growing consumer concern about the environmental impact of food production and transport, including "food miles". The case describes the company's growth, which includes the use of owned land and outgrowers for production, the addition of value-added processing to obtain premium prices, and the introduction of global certification to ensure food safety and meet retailer and consumer requirements. The case also discusses the potential impact of increased consumer awareness of ethical sourcing and introduces the potential trade off between local production and economic development.


Case Authors : David E. Bell, Brian Milder, Mary L. Shelman

Topic : Sales & Marketing

Related Areas : Emerging markets, Ethics, Growth strategy, Operations management, Regulation, Sustainability




Calculating Net Present Value (NPV) at 6% for Vegpro Group: Growing in Harmony, Spanish Version Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10004396) -10004396 - -
Year 1 3466334 -6538062 3466334 0.9434 3270126
Year 2 3975200 -2562862 7441534 0.89 3537914
Year 3 3944372 1381510 11385906 0.8396 3311771
Year 4 3232371 4613881 14618277 0.7921 2560341
TOTAL 14618277 12680152




The Net Present Value at 6% discount rate is 2675756

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

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 Vegpro Food 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. Vegpro Food 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 Vegpro Group: Growing in Harmony, Spanish Version

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 Vegpro Food 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 Vegpro Food 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 (10004396) -10004396 - -
Year 1 3466334 -6538062 3466334 0.8696 3014203
Year 2 3975200 -2562862 7441534 0.7561 3005822
Year 3 3944372 1381510 11385906 0.6575 2593489
Year 4 3232371 4613881 14618277 0.5718 1848119
TOTAL 10461633


The Net NPV after 4 years is 457237

(10461633 - 10004396 )








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 (10004396) -10004396 - -
Year 1 3466334 -6538062 3466334 0.8333 2888612
Year 2 3975200 -2562862 7441534 0.6944 2760556
Year 3 3944372 1381510 11385906 0.5787 2282623
Year 4 3232371 4613881 14618277 0.4823 1558821
TOTAL 9490611


The Net NPV after 4 years is -513785

At 20% discount rate the NPV is negative (9490611 - 10004396 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Vegpro Food 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 Vegpro Food has a NPV value higher than Zero then finance managers at Vegpro Food 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 Vegpro Food, then the stock price of the Vegpro Food 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 Vegpro Food 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 will be a multi year spillover effect of various taxation regulations.

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 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.

Understanding of risks involved in 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.






Negotiation Strategy of Vegpro Group: Growing in Harmony, Spanish Version

References & Further Readings

David E. Bell, Brian Milder, Mary L. Shelman (2018), "Vegpro Group: Growing in Harmony, Spanish Version Harvard Business Review Case Study. Published by HBR Publications.


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