CJ E&M: Creating a K-Culture in the U.S. 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 CJ E&M: Creating a K-Culture in the U.S. case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. CJ E&M: Creating a K-Culture in the U.S. case study is a Harvard Business School (HBR) case study written by Elie Ofek, Sang-Hoon Kim, Michael Norris. The CJ E&M: Creating a K-Culture in the U.S. (referred as “Kcon Cj” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Economy, Marketing, 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

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Case Description of CJ E&M: Creating a K-Culture in the U.S. Case Study

Buoyed by the success of K-pop music and K-drama television shows in Asian countries, Jay Lee, Chairman of the South Korean conglomerate CJ Group, believed that the time was ripe for taking Korean cultural content to the West. One initiative, carried out by the Group's Entertainment & Media (E&M) division, was a daylong fan convention, called 'KCON' , that was held in Irvine CA in October 2012 and which featured various Korean cultural elements, such as music, dance, film, and food. In the spring of 2013, Miky Lee, the Group's Vice Chairman, called a meeting with key executives to review the results of KCON 2012's and make a recommendation to the Chairman on whether to hold a similar event in 2013. As part of their deliberations, the executives were expected to consider where a potential 2013 convention should be held, which artists to invite, which target consumers to focus on, how to price tickets and how to attract more sponsors. With KCON 2012 having lost money, despite a robust turnout, it was far from clear whether to repeat the event and, if so, whether its scale should be expanded beyond 2012's $1.1 million budget. With CJ recently opening a chain of mid-market Korean food restaurants in the Los Angeles area called Bibigo, the meeting would also touch on the restaurant's U.S. growth plans and how they might be connected to KCON. More broadly, the executives had to wrestle with the question of whether Americans would ever really embrace Hallyu, the Korean Wave, beyond one-off success stories like PSY's "Gangnam Style". And even if they believed so, was KCON the right vehicle to make it happen, or was the event just a waste of the company's time and money? CJ Group's Vice Chairman, Miky Lee, and other CJ executives need to review the results of KCON 2012, the company's first Korean pop-culture convention, and make a recommendation to the Chairman on whether to hold a similar event in 2013. The executives were expected to consider where a potential 2013 convention should be held, which artists to invite, which target consumers to focus on, how to price tickets and how to attract more sponsors. With KCON 2012 having lost money, it was unclear whether to repeat the event and, if so, what budget to allocate.

Case Authors : Elie Ofek, Sang-Hoon Kim, Michael Norris

Topic : Sales & Marketing

Related Areas : Economy, Marketing, Strategy

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Calculating Net Present Value (NPV) at 6% for CJ E&M: Creating a K-Culture in the U.S. Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10021255)	-10021255	-	-
Year 1	3465007	-6556248	3465007	0.9434	3268875
Year 2	3957891	-2598357	7422898	0.89	3522509
Year 3	3954872	1356515	11377770	0.8396	3320587
Year 4	3231039	4587554	14608809	0.7921	2559286
TOTAL			14608809		12671256

The Net Present Value at 6% discount rate is 2650001

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

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Formula and Steps to Calculate Net Present Value (NPV) of CJ E&M: Creating a K-Culture in the U.S.

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 Kcon Cj 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 Kcon Cj 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	(10021255)	-10021255	-	-
Year 1	3465007	-6556248	3465007	0.8696	3013050
Year 2	3957891	-2598357	7422898	0.7561	2992734
Year 3	3954872	1356515	11377770	0.6575	2600393
Year 4	3231039	4587554	14608809	0.5718	1847357
TOTAL					10453533

The Net NPV after 4 years is 432278

(10453533 - 10021255 )

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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	(10021255)	-10021255	-	-
Year 1	3465007	-6556248	3465007	0.8333	2887506
Year 2	3957891	-2598357	7422898	0.6944	2748535
Year 3	3954872	1356515	11377770	0.5787	2288699
Year 4	3231039	4587554	14608809	0.4823	1558179
TOTAL					9482919

The Net NPV after 4 years is -538336

At 20% discount rate the NPV is negative (9482919 - 10021255 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Kcon Cj 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 Kcon Cj has a NPV value higher than Zero then finance managers at Kcon Cj 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 Kcon Cj, then the stock price of the Kcon Cj 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 Kcon Cj 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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

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 CJ E&M: Creating a K-Culture in the U.S.

References & Further Readings

Elie Ofek, Sang-Hoon Kim, Michael Norris (2018), "CJ E&M: Creating a K-Culture in the U.S. Harvard Business Review Case Study. Published by HBR Publications.