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Reinventing Best Buy 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 Reinventing Best Buy case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Reinventing Best Buy case study is a Harvard Business School (HBR) case study written by John R. Wells, Gabriel Ellsworth. The Reinventing Best Buy (referred as “Joly Buy” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Business models, Change management, Competition, Costs, Customers, Growth strategy, Innovation, IT, Pricing, Supply chain.

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 Reinventing Best Buy Case Study


On March 1, 2017, Best Buy Company, Inc., North America's largest retailer of consumer electronics and appliances, announced a third year of comparable-store sales increases and a 20.8% increase in domestic comparable online sales. These results were in marked contrast to four years of declining comparable-store sales from 2010 through 2013. The stock price rose 17% in March, and on April 20, 2017, it surpassed $50 for the first time since January 2008. When CEO Hubert Joly took over in September 2012, Best Buy was losing share to Amazon.com, which was encouraging consumers to view products at Best Buy and other physical stores and then buy them for a lower price online, a practice known as "showrooming." Undaunted, Joly had encouraged the practice, convinced that it presented an opportunity to sell to customers as long as Best Buy's prices were competitive. Joly had committed the company to a multi-channel strategy in North America and exited struggling international operations. Operating margins had increased as a result, but growth was still proving elusive. In early 2017, Joly announced that his "Renew Blue" turnaround effort was complete and that he was now intent on creating the New Blue. Would the new strategy be enough to stop Amazon's advances?


Case Authors : John R. Wells, Gabriel Ellsworth

Topic : Strategy & Execution

Related Areas : Business models, Change management, Competition, Costs, Customers, Growth strategy, Innovation, IT, Pricing, Supply chain




Calculating Net Present Value (NPV) at 6% for Reinventing Best Buy Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10028033) -10028033 - -
Year 1 3468428 -6559605 3468428 0.9434 3272102
Year 2 3980859 -2578746 7449287 0.89 3542950
Year 3 3956882 1378136 11406169 0.8396 3322274
Year 4 3245960 4624096 14652129 0.7921 2571104
TOTAL 14652129 12708431




The Net Present Value at 6% discount rate is 2680398

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. Net Present Value
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Joly Buy 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 Joly Buy 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 Reinventing Best Buy

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 Joly Buy 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 Joly Buy 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 (10028033) -10028033 - -
Year 1 3468428 -6559605 3468428 0.8696 3016024
Year 2 3980859 -2578746 7449287 0.7561 3010101
Year 3 3956882 1378136 11406169 0.6575 2601714
Year 4 3245960 4624096 14652129 0.5718 1855888
TOTAL 10483728


The Net NPV after 4 years is 455695

(10483728 - 10028033 )








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 (10028033) -10028033 - -
Year 1 3468428 -6559605 3468428 0.8333 2890357
Year 2 3980859 -2578746 7449287 0.6944 2764485
Year 3 3956882 1378136 11406169 0.5787 2289862
Year 4 3245960 4624096 14652129 0.4823 1565374
TOTAL 9510079


The Net NPV after 4 years is -517954

At 20% discount rate the NPV is negative (9510079 - 10028033 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Joly Buy 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 Joly Buy has a NPV value higher than Zero then finance managers at Joly Buy 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 Joly Buy, then the stock price of the Joly Buy 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 Joly Buy 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 –

Understanding of risks involved in the project.

What can impact the cash flow of 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 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.






Negotiation Strategy of Reinventing Best Buy

References & Further Readings

John R. Wells, Gabriel Ellsworth (2018), "Reinventing Best Buy Harvard Business Review Case Study. Published by HBR Publications.


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