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Wawa: Supply Change Management 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 Wawa: Supply Change Management case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Wawa: Supply Change Management case study is a Harvard Business School (HBR) case study written by Robert W. Keidel. The Wawa: Supply Change Management (referred as “Wawa Wawa's” 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 Wawa: Supply Change Management Case Study


Wawa was founded in 1803 and incorporated in 1865 as a textile manufacturer. In the early 1900s, the company opened a dairy; in 1964, Wawa Food Markets' first store was established as an outlet for dairy products. By mid-2007, Wawa, headquartered outside Philadelphia, had grown into a chain of 564 convenience stores (200 of which sold gasoline) within a 250-mile radius. A privately-owned firm, Wawa employed over 16,000 people. 2006 sales were $4.673 billion, an increase of 19.6 per cent over the prior year. Wawa was widely admired as a highly effective and humane organization with a loyal and expanding body of customers. This case addresses Wawa's supply chain management (SCM) in the context of strategic direction, organizational design, and future growth opportunities. Over an eight-year period, Wawa had transformed its supply chain from a disjointed array of pieces into a coherent, high-functioning system. Issues before the company now included (1) the relation between SCM & competitiveness; (2) the nature of the typical store, and store manager; and (3) possible expansion beyond Wawa's current area of operations. Another question concerned Wawa's stores. Historically, these places had featured a friendly, ambience where "everybody knows your name" but the company was moving towards larger, more standardized units with fewer offerings, with the goal of minimizing customer throughput time. What would this shift mean for the role of the store manager, and for the overall customer experience? Finally, to what extent was Wawa "landlocked" in its concentrated, middle-Atlantic market? Could--and should--the company attempt to export its distinctive value proposition, culture, and methods to other geographic areas?


Case Authors : Robert W. Keidel

Topic : Strategy & Execution

Related Areas : Strategy




Calculating Net Present Value (NPV) at 6% for Wawa: Supply Change Management Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10006430) -10006430 - -
Year 1 3443865 -6562565 3443865 0.9434 3248929
Year 2 3956008 -2606557 7399873 0.89 3520833
Year 3 3956620 1350063 11356493 0.8396 3322054
Year 4 3238617 4588680 14595110 0.7921 2565288
TOTAL 14595110 12657105


The Net Present Value at 6% discount rate is 2650675

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. Internal Rate of Return
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 Wawa Wawa's 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. Wawa Wawa's 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 Wawa: Supply Change Management

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 Wawa Wawa's 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 Wawa Wawa's 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 (10006430) -10006430 - -
Year 1 3443865 -6562565 3443865 0.8696 2994665
Year 2 3956008 -2606557 7399873 0.7561 2991310
Year 3 3956620 1350063 11356493 0.6575 2601542
Year 4 3238617 4588680 14595110 0.5718 1851690
TOTAL 10439207


The Net NPV after 4 years is 432777

(10439207 - 10006430 )






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 (10006430) -10006430 - -
Year 1 3443865 -6562565 3443865 0.8333 2869888
Year 2 3956008 -2606557 7399873 0.6944 2747228
Year 3 3956620 1350063 11356493 0.5787 2289711
Year 4 3238617 4588680 14595110 0.4823 1561833
TOTAL 9468659


The Net NPV after 4 years is -537771

At 20% discount rate the NPV is negative (9468659 - 10006430 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Wawa Wawa's 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 Wawa Wawa's has a NPV value higher than Zero then finance managers at Wawa Wawa's 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 Wawa Wawa's, then the stock price of the Wawa Wawa's 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 Wawa Wawa's 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 will be a multi year spillover effect of various taxation regulations.

What can impact the cash flow of the project.

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.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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

Robert W. Keidel (2018), "Wawa: Supply Change Management Harvard Business Review Case Study. Published by HBR Publications.