Cola Wars Continue: Coke vs. Pepsi in the Twenty-First Century 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 Cola Wars Continue: Coke vs. Pepsi in the Twenty-First Century case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Cola Wars Continue: Coke vs. Pepsi in the Twenty-First Century case study is a Harvard Business School (HBR) case study written by David B. Yoffie, Yusi Wang. The Cola Wars Continue: Coke vs. Pepsi in the Twenty-First Century (referred as “Cola Pepsi” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Competitive strategy, International business.

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 Cola Wars Continue: Coke vs. Pepsi in the Twenty-First Century Case Study

Examines the industry structure and competitive strategy of Coca-cola and Pepsi over 100 years of rivalry. New challenges of the 21st century included boosting flagging domestic cola sales and finding new revenue streams. Both firms also began to modify their bottling, pricing, and brand strategies. They looked to emerging international markets to fuel growth and broaden their brand portfolios to include noncarbonated beverages like tea, juice, sports drinks, and bottled water. For over a century, Coca-Cola and Pepsi-Cola had vied for the "throat share" of the world's beverage market. The most intense battles of the cola wars were fought over the $60 billion industry in the United States, where the average American consumes 53 gallons of carbonated soft drinks (CSD) per year. In a "carefully waged competitive struggle," from 1975 to 1995 both Coke and Pepsi had achieved average annual growth of around 10% as both U.S. and worldwide CSD consumption consistently rose. This cozy situation was threatened in the late 1990s, however, when U.S. CSD consumption dropped for two consecutive years and worldwide shipments slowed for both Coke and Pepsi. The case considers whether Coke's and Pepsi's era of sustained growth and profitability was coming to a close or whether this apparent slowdown was just another blip in the course of a century of enviable performance. A rewritten version of an earlier case by Michael E. Porter and David B. Yoffie.

Case Authors : David B. Yoffie, Yusi Wang

Topic : Strategy & Execution

Related Areas : Competitive strategy, International business

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Calculating Net Present Value (NPV) at 6% for Cola Wars Continue: Coke vs. Pepsi in the Twenty-First Century Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10023147)	-10023147	-	-
Year 1	3456539	-6566608	3456539	0.9434	3260886
Year 2	3977120	-2589488	7433659	0.89	3539623
Year 3	3941406	1351918	11375065	0.8396	3309280
Year 4	3225125	4577043	14600190	0.7921	2554601
TOTAL			14600190		12664390

The Net Present Value at 6% discount rate is 2641243

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. Profitability Index
3. Payback Period
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. Cola Pepsi 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 Cola Pepsi 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 Cola Wars Continue: Coke vs. Pepsi in the Twenty-First Century

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 Strategy & Execution 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 Cola Pepsi 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 Cola Pepsi 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	(10023147)	-10023147	-	-
Year 1	3456539	-6566608	3456539	0.8696	3005686
Year 2	3977120	-2589488	7433659	0.7561	3007274
Year 3	3941406	1351918	11375065	0.6575	2591538
Year 4	3225125	4577043	14600190	0.5718	1843976
TOTAL					10448474

The Net NPV after 4 years is 425327

(10448474 - 10023147 )

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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	(10023147)	-10023147	-	-
Year 1	3456539	-6566608	3456539	0.8333	2880449
Year 2	3977120	-2589488	7433659	0.6944	2761889
Year 3	3941406	1351918	11375065	0.5787	2280906
Year 4	3225125	4577043	14600190	0.4823	1555326
TOTAL					9478571

The Net NPV after 4 years is -544576

At 20% discount rate the NPV is negative (9478571 - 10023147 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Cola Pepsi 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 Cola Pepsi has a NPV value higher than Zero then finance managers at Cola Pepsi 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 Cola Pepsi, then the stock price of the Cola Pepsi 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 Cola Pepsi 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 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.

Understanding of risks involved in the project.

What can impact the cash flow of the project.

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

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 Cola Wars Continue: Coke vs. Pepsi in the Twenty-First Century

References & Further Readings

David B. Yoffie, Yusi Wang (2018), "Cola Wars Continue: Coke vs. Pepsi in the Twenty-First Century Harvard Business Review Case Study. Published by HBR Publications.