De Kuyper Royal Distillers: Three Centuries of Succession 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 De Kuyper Royal Distillers: Three Centuries of Succession case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. De Kuyper Royal Distillers: Three Centuries of Succession case study is a Harvard Business School (HBR) case study written by Venessa M. Strike. The De Kuyper Royal Distillers: Three Centuries of Succession (referred as “Kuyper De” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Leadership, Organizational culture, Strategy, Succession planning.

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 De Kuyper Royal Distillers: Three Centuries of Succession Case Study

De Kuyper Royal Distillers was a 300-year-old family firm in the Netherlands and produced the largest variety of liqueurs in the world. The firm had always been owned and controlled by the De Kuyper family. In 2009, Bob de Kuyper, the 10th generation to own and run the firm, retired from his position as managing director and an outsider was brought in as the interim managing director. In January 2010, Marc de Kuyper, the eldest son of Bob de Kuyper, worked for an outside firm in a marketing position. He had a strong desire to join the family firm and was trying to decide how to convince his father, and the family firm's supervisory board, that he had the capabilities to eventually take a leadership role in the family business. Was there a future for Marc at the family firm? What could he do, if anything, in the succession process?

Case Authors : Venessa M. Strike

Topic : Strategy & Execution

Related Areas : Leadership, Organizational culture, Strategy, Succession planning

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Calculating Net Present Value (NPV) at 6% for De Kuyper Royal Distillers: Three Centuries of Succession Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10029322)	-10029322	-	-
Year 1	3464312	-6565010	3464312	0.9434	3268219
Year 2	3976176	-2588834	7440488	0.89	3538782
Year 3	3938482	1349648	11378970	0.8396	3306825
Year 4	3251456	4601104	14630426	0.7921	2575458
TOTAL			14630426		12689284

The Net Present Value at 6% discount rate is 2659962

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. Payback Period
2. Internal Rate of Return
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. Timing of the expected cash flows – stockholders of Kuyper De 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. Kuyper De 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 De Kuyper Royal Distillers: Three Centuries of Succession

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 Kuyper De 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 Kuyper De 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	(10029322)	-10029322	-	-
Year 1	3464312	-6565010	3464312	0.8696	3012445
Year 2	3976176	-2588834	7440488	0.7561	3006560
Year 3	3938482	1349648	11378970	0.6575	2589616
Year 4	3251456	4601104	14630426	0.5718	1859031
TOTAL					10467652

The Net NPV after 4 years is 438330

(10467652 - 10029322 )

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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	(10029322)	-10029322	-	-
Year 1	3464312	-6565010	3464312	0.8333	2886927
Year 2	3976176	-2588834	7440488	0.6944	2761233
Year 3	3938482	1349648	11378970	0.5787	2279214
Year 4	3251456	4601104	14630426	0.4823	1568025
TOTAL					9495399

The Net NPV after 4 years is -533923

At 20% discount rate the NPV is negative (9495399 - 10029322 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Kuyper De 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 Kuyper De has a NPV value higher than Zero then finance managers at Kuyper De 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 Kuyper De, then the stock price of the Kuyper De 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 Kuyper De 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 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.

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.

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Negotiation Strategy of De Kuyper Royal Distillers: Three Centuries of Succession

References & Further Readings

Venessa M. Strike (2018), "De Kuyper Royal Distillers: Three Centuries of Succession Harvard Business Review Case Study. Published by HBR Publications.