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L.L. Bean: A Search for Growth 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 L.L. Bean: A Search for Growth case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. L.L. Bean: A Search for Growth case study is a Harvard Business School (HBR) case study written by Rajiv Lal, Walter J. Salmon, James Weber. The L.L. Bean: A Search for Growth (referred as “L.l Bean” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Developing employees, International business, Leadership, Marketing, Professional transitions, Risk management, Sales.

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 L.L. Bean: A Search for Growth Case Study


In mid-2003, CEO Chris McCormick felt L.L. Bean was in a good position to begin to grow again. For nearly 90 years, the company sold clothing and gear for outdoor enthusiasts through its catalogs and a single retail store in Freeport, Maine. In the three decades prior to 1996, sales growth averaged nearly 20% per year. In 1995, sales hit $1 billion, but stagnated for the next six years--growing at less than 2% annually. The company responded with a structural reorganization and investment in its Internet sales channel. In 2002 and early 2003, McCormick led an effort to reduce overhead and improve its internal systems, including the elimination of 1,000 jobs--which reduced year-round headcount by nearly 15%. After these initiatives, the company remained profitable and enjoyed a strong balance sheet, but sales growth remained near zero. Most significantly, between 2000 and 2002, L.L. Bean opened three retail stores in shopping malls outside Maine. McCormick viewed these three stores as the first of a chain of stores that would form a new selling channel and enable L.L. Bean to grow. Early results from the three new stores were below expectations; L.L. Bean spent significant time examining its retail store activities in an attempt to learn where it could improve. As the company began to apply those lessons in the stores, performance picked up, fueling McCormick's optimism that L.L. Bean could grow with retail stores.


Case Authors : Rajiv Lal, Walter J. Salmon, James Weber

Topic : Strategy & Execution

Related Areas : Developing employees, International business, Leadership, Marketing, Professional transitions, Risk management, Sales




Calculating Net Present Value (NPV) at 6% for L.L. Bean: A Search for Growth Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10011875) -10011875 - -
Year 1 3469573 -6542302 3469573 0.9434 3273182
Year 2 3963763 -2578539 7433336 0.89 3527735
Year 3 3954145 1375606 11387481 0.8396 3319976
Year 4 3239927 4615533 14627408 0.7921 2566326
TOTAL 14627408 12687219




The Net Present Value at 6% discount rate is 2675344

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. Profitability Index
2. Payback Period
3. Internal Rate of Return
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. Timing of the expected cash flows – stockholders of L.l Bean 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. L.l Bean 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 L.L. Bean: A Search for Growth

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 L.l Bean 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 L.l Bean 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 (10011875) -10011875 - -
Year 1 3469573 -6542302 3469573 0.8696 3017020
Year 2 3963763 -2578539 7433336 0.7561 2997174
Year 3 3954145 1375606 11387481 0.6575 2599915
Year 4 3239927 4615533 14627408 0.5718 1852439
TOTAL 10466548


The Net NPV after 4 years is 454673

(10466548 - 10011875 )








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 (10011875) -10011875 - -
Year 1 3469573 -6542302 3469573 0.8333 2891311
Year 2 3963763 -2578539 7433336 0.6944 2752613
Year 3 3954145 1375606 11387481 0.5787 2288278
Year 4 3239927 4615533 14627408 0.4823 1562465
TOTAL 9494667


The Net NPV after 4 years is -517208

At 20% discount rate the NPV is negative (9494667 - 10011875 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of L.l Bean 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 L.l Bean has a NPV value higher than Zero then finance managers at L.l Bean 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 L.l Bean, then the stock price of the L.l Bean 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 L.l Bean 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 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 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.

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 L.L. Bean: A Search for Growth

References & Further Readings

Rajiv Lal, Walter J. Salmon, James Weber (2018), "L.L. Bean: A Search for Growth Harvard Business Review Case Study. Published by HBR Publications.


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