Beacon Lakes 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 Beacon Lakes case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Beacon Lakes case study is a Harvard Business School (HBR) case study written by Arthur I Segel. The Beacon Lakes (referred as “Codina Lakes” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Economics, Financial management, Government, Leadership, Strategy, 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 Beacon Lakes Case Study

This case is accompanied by a Video Short that can be shown in class or included in a digital coursepack. Instructors should consider the timing of making the video available to students, as it may reveal key case details.In September 2001, Armando Codina, the CEO and chairman of Codina Group, is facing the decision of whether to go ahead as planned with its $220 million Beacon Lakes project, a 6.6-million-square-foot warehouse and office park in Miami's Airport West submarket. Although his firm has already spent more than two years and almost $2 million to get the project underway, the various obstacles ahead make him ponder whether to continue. Codina feels that an unsuccessful project could hurt his otherwise untainted career. Among the issues facing him: the uncertainty regarding the expansion of the Urban Development Boundary line to the west to include the site of the project, which is currently zoned to prohibit any type of development, and the heated environmental debate regarding the site's proximity to the Northwest Wellfield Protection Area and the Everglades National Park. Codina needs to analyze fully the economics of the deal, taking into account market conditions as well as the ultimate profitability of the project given the concessions that he is willing to make. Includes color exhibits.

Case Authors : Arthur I Segel

Topic : Finance & Accounting

Related Areas : Economics, Financial management, Government, Leadership, Strategy, Sustainability

Calculating Net Present Value (NPV) at 6% for Beacon Lakes Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10016327) -10016327 - -
Year 1 3467087 -6549240 3467087 0.9434 3270837
Year 2 3978073 -2571167 7445160 0.89 3540471
Year 3 3967214 1396047 11412374 0.8396 3330949
Year 4 3240130 4636177 14652504 0.7921 2566486
TOTAL 14652504 12708743

The Net Present Value at 6% discount rate is 2692416

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. Internal Rate of Return
2. Net Present Value
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 Codina Lakes 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. Codina Lakes 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 Beacon Lakes

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 Finance & Accounting 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 Codina Lakes 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 Codina Lakes 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 %
Cash Flows
Year 0 (10016327) -10016327 - -
Year 1 3467087 -6549240 3467087 0.8696 3014858
Year 2 3978073 -2571167 7445160 0.7561 3007995
Year 3 3967214 1396047 11412374 0.6575 2608508
Year 4 3240130 4636177 14652504 0.5718 1852555
TOTAL 10483915

The Net NPV after 4 years is 467588

(10483915 - 10016327 )

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 %
Cash Flows
Year 0 (10016327) -10016327 - -
Year 1 3467087 -6549240 3467087 0.8333 2889239
Year 2 3978073 -2571167 7445160 0.6944 2762551
Year 3 3967214 1396047 11412374 0.5787 2295841
Year 4 3240130 4636177 14652504 0.4823 1562563
TOTAL 9510194

The Net NPV after 4 years is -506133

At 20% discount rate the NPV is negative (9510194 - 10016327 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Codina Lakes 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 Codina Lakes has a NPV value higher than Zero then finance managers at Codina Lakes 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 Codina Lakes, then the stock price of the Codina Lakes 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 Codina Lakes 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 can impact the cash flow of 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.

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.

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

Arthur I Segel (2018), "Beacon Lakes Harvard Business Review Case Study. Published by HBR Publications.