Ahold versus Tesco--Analyzing Performance 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 Ahold versus Tesco--Analyzing Performance case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Ahold versus Tesco--Analyzing Performance case study is a Harvard Business School (HBR) case study written by Suraj Srinivasan, Penelope Rossano. The Ahold versus Tesco--Analyzing Performance (referred as “Ahold Dupont” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Assessing performance, Financial analysis, Financial management.

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 Ahold versus Tesco--Analyzing Performance Case Study

The case relates to understanding and comparing the performance of two leading retail companies-Ahold and Tesco. The case introduces the tools of Dupont and Modified Dupont Decomposition. While performance as measured by return on equity has been similar for the two companies, Ahold has had significantly better stock market performance compared to Tesco. Ahold also has a significant amount of cash on its balance sheet leading to low levels of net debt. The case requires students to analyze performance using Modified Dupont Decomposition techniques to assess if firm performance is resulting from operating profitability or from financial leverage and then suggest strategies to improve performance. To perform the modified Dupont Decomposition, students learn how to reformat and condense the balance sheet and income statement to separately measure profitability arising from operating activities and financing activities. Students also see how excess cash holdings can depress profitability and what factors should drive the appropriate level of leverage for a company.

Case Authors : Suraj Srinivasan, Penelope Rossano

Topic : Finance & Accounting

Related Areas : Assessing performance, Financial analysis, Financial management

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Calculating Net Present Value (NPV) at 6% for Ahold versus Tesco--Analyzing Performance Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019920)	-10019920	-	-
Year 1	3470343	-6549577	3470343	0.9434	3273908
Year 2	3962402	-2587175	7432745	0.89	3526524
Year 3	3940624	1353449	11373369	0.8396	3308624
Year 4	3247703	4601152	14621072	0.7921	2572485
TOTAL			14621072		12681541

The Net Present Value at 6% discount rate is 2661621

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. Profitability Index
2. Net Present Value
3. Payback Period
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. Timing of the expected cash flows – stockholders of Ahold Dupont 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. Ahold Dupont shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Ahold versus Tesco--Analyzing Performance

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 Ahold Dupont 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 Ahold Dupont 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	(10019920)	-10019920	-	-
Year 1	3470343	-6549577	3470343	0.8696	3017690
Year 2	3962402	-2587175	7432745	0.7561	2996145
Year 3	3940624	1353449	11373369	0.6575	2591024
Year 4	3247703	4601152	14621072	0.5718	1856885
TOTAL					10461744

The Net NPV after 4 years is 441824

(10461744 - 10019920 )

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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	(10019920)	-10019920	-	-
Year 1	3470343	-6549577	3470343	0.8333	2891953
Year 2	3962402	-2587175	7432745	0.6944	2751668
Year 3	3940624	1353449	11373369	0.5787	2280454
Year 4	3247703	4601152	14621072	0.4823	1566215
TOTAL					9490289

The Net NPV after 4 years is -529631

At 20% discount rate the NPV is negative (9490289 - 10019920 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ahold Dupont 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 Ahold Dupont has a NPV value higher than Zero then finance managers at Ahold Dupont 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 Ahold Dupont, then the stock price of the Ahold Dupont 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 Ahold Dupont 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 can impact the cash flow of the project.

Understanding of risks involved in 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 Ahold versus Tesco--Analyzing Performance

References & Further Readings

Suraj Srinivasan, Penelope Rossano (2018), "Ahold versus Tesco--Analyzing Performance Harvard Business Review Case Study. Published by HBR Publications.