×




Tiny Prints (A) 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 Tiny Prints (A) case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Tiny Prints (A) case study is a Harvard Business School (HBR) case study written by Mike Child, Sara Rosenthal. The Tiny Prints (A) (referred as “Prints Tiny” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, .

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 Tiny Prints (A) Case Study


The Tiny Prints case describes the founding of the online stationery company in 2004, through its growth and evolution to 2007. The three cofounders bootstrapped the company from the beginning, primarily so that they could retain control over the decision-making and strategic direction of the company. While that decision allowed the cofounders flexibility and independence, it also led to capital constraints and a "good enough" culture that had a variety of positive and negative implications for the company. Ultimately, Tiny Prints was able to grow because of its very specific focus on the birth announcement, and later holiday, market, an emphasis on customer service and innovations in design and distribution. As of 2007, the founders faced questions regarding their future growth strategy, particularly given increasing competition in the market, and were at an inflection point where they needed to consider the important decision of bringing in outside capital. Part B of the case explores the management team's decision to move forward with a purchase offer from Shutterfly or to maintain control of the company and continue to grow organically.


Case Authors : Mike Child, Sara Rosenthal

Topic : Strategy & Execution

Related Areas :




Calculating Net Present Value (NPV) at 6% for Tiny Prints (A) Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10027575) -10027575 - -
Year 1 3443445 -6584130 3443445 0.9434 3248533
Year 2 3977028 -2607102 7420473 0.89 3539541
Year 3 3947390 1340288 11367863 0.8396 3314305
Year 4 3239330 4579618 14607193 0.7921 2565853
TOTAL 14607193 12668231


The Net Present Value at 6% discount rate is 2640656

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. Payback Period
2. Net Present Value
3. Internal Rate of Return
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. Prints Tiny 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 Prints Tiny have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.




Formula and Steps to Calculate Net Present Value (NPV) of Tiny Prints (A)

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 Prints Tiny 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 Prints Tiny 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 (10027575) -10027575 - -
Year 1 3443445 -6584130 3443445 0.8696 2994300
Year 2 3977028 -2607102 7420473 0.7561 3007205
Year 3 3947390 1340288 11367863 0.6575 2595473
Year 4 3239330 4579618 14607193 0.5718 1852097
TOTAL 10449075


The Net NPV after 4 years is 421500

(10449075 - 10027575 )






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 (10027575) -10027575 - -
Year 1 3443445 -6584130 3443445 0.8333 2869538
Year 2 3977028 -2607102 7420473 0.6944 2761825
Year 3 3947390 1340288 11367863 0.5787 2284369
Year 4 3239330 4579618 14607193 0.4823 1562177
TOTAL 9477909


The Net NPV after 4 years is -549666

At 20% discount rate the NPV is negative (9477909 - 10027575 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Prints Tiny 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 Prints Tiny has a NPV value higher than Zero then finance managers at Prints Tiny 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 Prints Tiny, then the stock price of the Prints Tiny 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 Prints Tiny 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.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What can impact the cash flow of the project.

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

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.




References & Further Readings

Mike Child, Sara Rosenthal (2018), "Tiny Prints (A) Harvard Business Review Case Study. Published by HBR Publications.