Natura Cosmeticos, S.A., Spanish Version 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 Natura Cosmeticos, S.A., Spanish Version case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Natura Cosmeticos, S.A., Spanish Version case study is a Harvard Business School (HBR) case study written by Robert G. Eccles, George Serafeim, James Heffernan. The Natura Cosmeticos, S.A., Spanish Version (referred as “Natura Integrated” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Decision making, Internet, 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 Natura Cosmeticos, S.A., Spanish Version Case Study

Rodolfo Guttilla, Director of Corporate Affairs for Natura CosmA©ticos S.A. (Natura), prepared for a meeting with key stakeholders to discuss the future of integrated reporting at Natura. A cosmetics company with a strong brand, robust growth in international and domestic markets, and premium price and margins, Natura was consistently rated as one of the preferred places to work in Brazil. Its focus on social and environmental responsibility was a source of innovation; strong employee motivation contributed to the company's superior productivity and market share gain in Brazil's cosmetics, fragrances, and toiletries (CF&T) industry. By 2009, Natura's direct sales business model generated income for over 1 million people in Brazil and Latin America. Natura was the first organization in Brazil to produce an integrated report. Senior leadership was convinced that Natura's success over the years had been aided by its corporate responsibility and strategy to continuously seek improvements in both financial and nonfinancial (e.g., environmental, social, and governance) performance. As he prepared for the meeting, Guttilla considered the future of integrated reporting for Natura. What should the future of integrated reporting be like at Natura? How could the organization increase society's participation in the collaborative effort to develop new solutions to today's most challenging problems? How could the report provide a clearer representation of the organization's strategy and its ability to create and sustain value over the long term? And finally, how could web-based technologies be used to promote the organization's integrated reporting and sustainable development objectives?

Case Authors : Robert G. Eccles, George Serafeim, James Heffernan

Topic : Finance & Accounting

Related Areas : Decision making, Internet, Sustainability

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Calculating Net Present Value (NPV) at 6% for Natura Cosmeticos, S.A., Spanish Version Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10009298)	-10009298	-	-
Year 1	3463439	-6545859	3463439	0.9434	3267395
Year 2	3960728	-2585131	7424167	0.89	3525034
Year 3	3967639	1382508	11391806	0.8396	3331306
Year 4	3243093	4625601	14634899	0.7921	2568833
TOTAL			14634899		12692569

The Net Present Value at 6% discount rate is 2683271

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. Internal Rate of Return
2. Payback Period
3. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Natura Integrated 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 Natura Integrated 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 Natura Cosmeticos, S.A., Spanish Version

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 Natura Integrated 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 Natura Integrated 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	(10009298)	-10009298	-	-
Year 1	3463439	-6545859	3463439	0.8696	3011686
Year 2	3960728	-2585131	7424167	0.7561	2994879
Year 3	3967639	1382508	11391806	0.6575	2608787
Year 4	3243093	4625601	14634899	0.5718	1854249
TOTAL					10469601

The Net NPV after 4 years is 460303

(10469601 - 10009298 )

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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	(10009298)	-10009298	-	-
Year 1	3463439	-6545859	3463439	0.8333	2886199
Year 2	3960728	-2585131	7424167	0.6944	2750506
Year 3	3967639	1382508	11391806	0.5787	2296087
Year 4	3243093	4625601	14634899	0.4823	1563992
TOTAL					9496784

The Net NPV after 4 years is -512514

At 20% discount rate the NPV is negative (9496784 - 10009298 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Natura Integrated 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 Natura Integrated has a NPV value higher than Zero then finance managers at Natura Integrated 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 Natura Integrated, then the stock price of the Natura Integrated 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 Natura Integrated 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.

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.

What can impact the cash flow of 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.

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Negotiation Strategy of Natura Cosmeticos, S.A., Spanish Version

References & Further Readings

Robert G. Eccles, George Serafeim, James Heffernan (2018), "Natura Cosmeticos, S.A., Spanish Version Harvard Business Review Case Study. Published by HBR Publications.