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Wadeshwar Restaurants: Strategies for Growth 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 Wadeshwar Restaurants: Strategies for Growth case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Wadeshwar Restaurants: Strategies for Growth case study is a Harvard Business School (HBR) case study written by Atul Arun Pathak. The Wadeshwar Restaurants: Strategies for Growth (referred as “Restaurants Highway” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, .

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 Wadeshwar Restaurants: Strategies for Growth Case Study


In 2014, the owner of a family business that includes two fast-food restaurants, a highway restaurant and a catering services operation located in Pune, India, is confident that his business is at the cusp of taking off on a path that will make it significantly larger in scale. He is evaluating three alternatives: setting up a chain of small restaurants with a central kitchen facility, creating a couple of large restaurants similar to those that he has at present or investing in new highway restaurants. He also must consider whether he is ready to expand to other cities in India or globally and whether to develop family-owned land, buy new property or lease facilities for his planned ventures. He needs to come up with a strategy that best meets the needs of a changing business environment and also leverages his company's existing resources and capabilities. Before the next management meeting, he must decide what to do, in what sequence to take up the opportunities available, how to go about operationalizing the plan and also what design fallback options can be designed in case things go wrong. Atul Arun Pathak is affiliated with Xavier School of Management.


Case Authors : Atul Arun Pathak

Topic : Strategy & Execution

Related Areas :




Calculating Net Present Value (NPV) at 6% for Wadeshwar Restaurants: Strategies for Growth Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10014728) -10014728 - -
Year 1 3465124 -6549604 3465124 0.9434 3268985
Year 2 3979547 -2570057 7444671 0.89 3541783
Year 3 3938863 1368806 11383534 0.8396 3307145
Year 4 3235693 4604499 14619227 0.7921 2562972
TOTAL 14619227 12680885




The Net Present Value at 6% discount rate is 2666157

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. Internal Rate of Return
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. Restaurants Highway 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 Restaurants Highway 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 Wadeshwar Restaurants: Strategies for Growth

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 Restaurants Highway 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 Restaurants Highway 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 (10014728) -10014728 - -
Year 1 3465124 -6549604 3465124 0.8696 3013151
Year 2 3979547 -2570057 7444671 0.7561 3009109
Year 3 3938863 1368806 11383534 0.6575 2589866
Year 4 3235693 4604499 14619227 0.5718 1850018
TOTAL 10462145


The Net NPV after 4 years is 447417

(10462145 - 10014728 )








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 (10014728) -10014728 - -
Year 1 3465124 -6549604 3465124 0.8333 2887603
Year 2 3979547 -2570057 7444671 0.6944 2763574
Year 3 3938863 1368806 11383534 0.5787 2279435
Year 4 3235693 4604499 14619227 0.4823 1560423
TOTAL 9491035


The Net NPV after 4 years is -523693

At 20% discount rate the NPV is negative (9491035 - 10014728 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Restaurants Highway 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 Restaurants Highway has a NPV value higher than Zero then finance managers at Restaurants Highway 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 Restaurants Highway, then the stock price of the Restaurants Highway 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 Restaurants Highway 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 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.

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 Wadeshwar Restaurants: Strategies for Growth

References & Further Readings

Atul Arun Pathak (2018), "Wadeshwar Restaurants: Strategies for Growth Harvard Business Review Case Study. Published by HBR Publications.


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