Heineken-Brewing a Better 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 Heineken-Brewing a Better World case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Heineken-Brewing a Better World case study is a Harvard Business School (HBR) case study written by Forest Reinhardt, Jose B. Alvarez, Tonia Junker, Daniela Beyersdorfer. The Heineken-Brewing a Better World (referred as “Heineken Sourcing” 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, Social responsibility, Supply chain, 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

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Case Description of Heineken-Brewing a Better World Case Study

The Dutch company HEINEKEN, one of the leading global brewers known for its brands like Heineken, Amstel, or Desperados and for its award-winning marketing campaigns, seeks to closely integrate its long-term sustainability "Brewing a Better World"-approach into its corporate strategy. HEINEKEN had set itself ambitious 2015 and 2020 sustainability targets in six pillar areas around Energy/CO2, Water, Sustainable Sourcing, Responsible Consumption, Community/Inclusive Growth, and Health & Safety. The case zooms in on HEINEKEN's efforts in the sustainable sourcing pillar, with its work on farming standards and supplier code as well as its support for local sourcing programs in the growing African market. HEINEKEN's management finds that marketing its achievements in these sustainability areas poses new challenges though. For example, its current "mass-balance" sourcing in which sustainable and traditional material got mixed in the supply chain did not allow for effective communication on a given bottle. But was this reason enough to try to move to "segregated" sourcing, if that was even reasonable?

Case Authors : Forest Reinhardt, Jose B. Alvarez, Tonia Junker, Daniela Beyersdorfer

Topic : Strategy & Execution

Related Areas : Competitive strategy, International business, Social responsibility, Supply chain, Sustainability

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Calculating Net Present Value (NPV) at 6% for Heineken-Brewing a Better World Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10006190)	-10006190	-	-
Year 1	3470322	-6535868	3470322	0.9434	3273889
Year 2	3961243	-2574625	7431565	0.89	3525492
Year 3	3974716	1400091	11406281	0.8396	3337248
Year 4	3226342	4626433	14632623	0.7921	2555565
TOTAL			14632623		12692194

The Net Present Value at 6% discount rate is 2686004

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. Net Present Value
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Heineken Sourcing 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 Heineken Sourcing 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 Heineken-Brewing a Better 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 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 Heineken Sourcing 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 Heineken Sourcing 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	(10006190)	-10006190	-	-
Year 1	3470322	-6535868	3470322	0.8696	3017671
Year 2	3961243	-2574625	7431565	0.7561	2995269
Year 3	3974716	1400091	11406281	0.6575	2613440
Year 4	3226342	4626433	14632623	0.5718	1844672
TOTAL					10471052

The Net NPV after 4 years is 464862

(10471052 - 10006190 )

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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	(10006190)	-10006190	-	-
Year 1	3470322	-6535868	3470322	0.8333	2891935
Year 2	3961243	-2574625	7431565	0.6944	2750863
Year 3	3974716	1400091	11406281	0.5787	2300183
Year 4	3226342	4626433	14632623	0.4823	1555913
TOTAL					9498894

The Net NPV after 4 years is -507296

At 20% discount rate the NPV is negative (9498894 - 10006190 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Heineken Sourcing 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 Heineken Sourcing has a NPV value higher than Zero then finance managers at Heineken Sourcing 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 Heineken Sourcing, then the stock price of the Heineken Sourcing 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 Heineken Sourcing 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 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 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 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 Heineken-Brewing a Better World

References & Further Readings

Forest Reinhardt, Jose B. Alvarez, Tonia Junker, Daniela Beyersdorfer (2018), "Heineken-Brewing a Better World Harvard Business Review Case Study. Published by HBR Publications.