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Kingston Family Vineyards 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 Kingston Family Vineyards case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Kingston Family Vineyards case study is a Harvard Business School (HBR) case study written by Alyssa Rapp, Kaitlin Malloy. The Kingston Family Vineyards (referred as “Kingston Courtney” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Strategy.

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 Kingston Family Vineyards Case Study


In 1998, Courtney Kingston persuaded her family to expand their ranch in Chile from dairy and cattle into wine. By March 2016, Kingston Family Vineyards had a strong international brand for its small-production wines and successfully sold the remaining top-tier grapes to other Chilean winemakers. But they faced key choices regarding focus and growth. As Courtney packed her bags for Chile to attend the annual meeting of the family business, she considered three diverging paths. One option was to increase production of their highly rated, handcrafted wines, which had established the vineyard's reputation for quality, pursuing sufficient scale to turn a profit on the winery. Alternatively, the Kingstons could refocus on the vineyard, as they had originally planned, playing to their strengths in farming expertise and leveraging their primary asset - the land. A third possibility was to Invest in Chile's burgeoning tourism market, and open a boutique hotel in Casablanca's wine country. Courtney wondered how best to preserve the family's land for the next generation while contributing to the greater Casablanca Valley community. This case explores these three strategic possibilities and their potential economic impact. Kingston Family Vineyards - Trade and Education video provides an overview of their history and approach to winemaking in Casablanca Valley, Chile. https://vimeo.com/201833299 (TRT: 04:38)


Case Authors : Alyssa Rapp, Kaitlin Malloy

Topic : Strategy & Execution

Related Areas : Strategy




Calculating Net Present Value (NPV) at 6% for Kingston Family Vineyards Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10007745) -10007745 - -
Year 1 3459315 -6548430 3459315 0.9434 3263505
Year 2 3981599 -2566831 7440914 0.89 3543609
Year 3 3953942 1387111 11394856 0.8396 3319806
Year 4 3244156 4631267 14639012 0.7921 2569675
TOTAL 14639012 12696595


The Net Present Value at 6% discount rate is 2688850

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




Formula and Steps to Calculate Net Present Value (NPV) of Kingston Family Vineyards

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 Kingston Courtney 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 Kingston Courtney 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 (10007745) -10007745 - -
Year 1 3459315 -6548430 3459315 0.8696 3008100
Year 2 3981599 -2566831 7440914 0.7561 3010661
Year 3 3953942 1387111 11394856 0.6575 2599781
Year 4 3244156 4631267 14639012 0.5718 1854857
TOTAL 10473399


The Net NPV after 4 years is 465654

(10473399 - 10007745 )






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 (10007745) -10007745 - -
Year 1 3459315 -6548430 3459315 0.8333 2882763
Year 2 3981599 -2566831 7440914 0.6944 2764999
Year 3 3953942 1387111 11394856 0.5787 2288161
Year 4 3244156 4631267 14639012 0.4823 1564504
TOTAL 9500427


The Net NPV after 4 years is -507318

At 20% discount rate the NPV is negative (9500427 - 10007745 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Kingston Courtney 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 Kingston Courtney has a NPV value higher than Zero then finance managers at Kingston Courtney 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 Kingston Courtney, then the stock price of the Kingston Courtney 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 Kingston Courtney 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 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.

Understanding of risks involved in the project.

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.




References & Further Readings

Alyssa Rapp, Kaitlin Malloy (2018), "Kingston Family Vineyards Harvard Business Review Case Study. Published by HBR Publications.