Let's Take This Private: Linens 'n Things Versus Bed Bath & Beyond 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 Let's Take This Private: Linens 'n Things Versus Bed Bath & Beyond case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Let's Take This Private: Linens 'n Things Versus Bed Bath & Beyond case study is a Harvard Business School (HBR) case study written by Frank C. Schultz, Tina Doede, Elizabeth Nicknam-Retana. The Let's Take This Private: Linens 'n Things Versus Bed Bath & Beyond (referred as “Lnt Bbby” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Competitive strategy, Entrepreneurial finance.

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 Let's Take This Private: Linens 'n Things Versus Bed Bath & Beyond Case Study

The case focuses on the housewares subgroup within the overall retail sector. During the period considered by the case (1970s to 2006), housewares in North America saw the emergence of two "big-box" retailers - Linens 'n Things (LNT) and Bed Bath & Beyond (BBBY). LNT and BBBY were founded within four years of each other and their corporate headquarters were just 16 miles apart. Despite this remarkable similarity in starting conditions, their performance outcomes diverged sharply. On the surface, both companies were pursuing a similar business-level strategy of cost leadership, but key strategic decisions led them down quite different evolutionary paths. Both companies focused on providing consumers with high-quality houseware goods in a no-frills, value-priced environment, but LNT's decision to build centralized warehouses - seemingly consistent with a cost leadership strategy - ended up bringing it into direct competition with Target and Walmart. In contrast, BBBY allowed for greater decentralization in decision making, thereby allowing more store-level decision making and greater customization to local consumers' tastes. As a result, BBBY was able to better differentiate itself from Walmart and Target. The case allows instructors to introduce basic strategy concepts, such as industry and environmental analysis, business-level strategies, core competencies and administrative heritage. At the time of the case (February 2006), BBBY's market capitalization was approximately $10.7 billion, while LNT had just been acquired for $1.3 billion by a private equity firm. The case begins right after the acquisition and takes the perspective of the new CEO of LNT, who is tasked with devising a turnaround plan.

Case Authors : Frank C. Schultz, Tina Doede, Elizabeth Nicknam-Retana

Topic : Strategy & Execution

Related Areas : Competitive strategy, Entrepreneurial finance

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Calculating Net Present Value (NPV) at 6% for Let's Take This Private: Linens 'n Things Versus Bed Bath & Beyond Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10017124)	-10017124	-	-
Year 1	3469058	-6548066	3469058	0.9434	3272696
Year 2	3967625	-2580441	7436683	0.89	3531172
Year 3	3950129	1369688	11386812	0.8396	3316604
Year 4	3246169	4615857	14632981	0.7921	2571270
TOTAL			14632981		12691743

The Net Present Value at 6% discount rate is 2674619

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. Profitability Index
3. Payback Period
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. Lnt Bbby 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 Lnt Bbby 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 Let's Take This Private: Linens 'n Things Versus Bed Bath & Beyond

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 Lnt Bbby 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 Lnt Bbby 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	(10017124)	-10017124	-	-
Year 1	3469058	-6548066	3469058	0.8696	3016572
Year 2	3967625	-2580441	7436683	0.7561	3000095
Year 3	3950129	1369688	11386812	0.6575	2597274
Year 4	3246169	4615857	14632981	0.5718	1856008
TOTAL					10469948

The Net NPV after 4 years is 452824

(10469948 - 10017124 )

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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	(10017124)	-10017124	-	-
Year 1	3469058	-6548066	3469058	0.8333	2890882
Year 2	3967625	-2580441	7436683	0.6944	2755295
Year 3	3950129	1369688	11386812	0.5787	2285954
Year 4	3246169	4615857	14632981	0.4823	1565475
TOTAL					9497606

The Net NPV after 4 years is -519518

At 20% discount rate the NPV is negative (9497606 - 10017124 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Lnt Bbby 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 Lnt Bbby has a NPV value higher than Zero then finance managers at Lnt Bbby 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 Lnt Bbby, then the stock price of the Lnt Bbby 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 Lnt Bbby 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 will be a multi year spillover effect of various taxation regulations.

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.

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 Let's Take This Private: Linens 'n Things Versus Bed Bath & Beyond

References & Further Readings

Frank C. Schultz, Tina Doede, Elizabeth Nicknam-Retana (2018), "Let's Take This Private: Linens 'n Things Versus Bed Bath & Beyond Harvard Business Review Case Study. Published by HBR Publications.