Ferran AdriA? and elBulli's Transformation, Spanish Version 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 Ferran AdriA? and elBulli's Transformation, Spanish Version case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Ferran AdriA? and elBulli's Transformation, Spanish Version case study is a Harvard Business School (HBR) case study written by Marcel Planellas, Silviya Svejenova. The Ferran AdriA? and elBulli's Transformation, Spanish Version (referred as “Adria Ferran” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, Change management, Creativity, Entrepreneurship, Innovation.

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 Ferran AdriA? and elBulli's Transformation, Spanish Version Case Study

The case tells the story of Chef Ferran AdriA? and describes the transformation of elBulli, a renowned Michelin three-star restaurant located in Spain's Costa Brava, since the restaurant's opening in 1961 until its closing in 2011. Why would Ferran AdriA? close elBulli? Was the iconic restaurant yet another financial crisis victim? Had the chef and his team tired of success or run out of creative juices, unable to keep up with the hectic innovative pace required to create new, ground-breaking menus year after year? What else could have possibly driven AdriA? to turn away from the restaurant's huge, untapped demand, with some two million reservation requests a year and a seating capacity for 8,000? Why would he risk turning this "gastronomic success" -a restaurant that had been named the world's best restaurant five times- into a foundation yet to be formulated and shaped? ESADE's case collection

Case Authors : Marcel Planellas, Silviya Svejenova

Topic : Strategy & Execution

Related Areas : Change management, Creativity, Entrepreneurship, Innovation

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Calculating Net Present Value (NPV) at 6% for Ferran AdriA? and elBulli's Transformation, Spanish Version Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10026438)	-10026438	-	-
Year 1	3453240	-6573198	3453240	0.9434	3257774
Year 2	3980091	-2593107	7433331	0.89	3542267
Year 3	3972067	1378960	11405398	0.8396	3335024
Year 4	3249950	4628910	14655348	0.7921	2574265
TOTAL			14655348		12709329

The Net Present Value at 6% discount rate is 2682891

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. Profitability Index
2. Payback Period
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 Adria Ferran 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. Adria Ferran 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 Ferran AdriA? and elBulli's Transformation, Spanish Version

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 Adria Ferran 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 Adria Ferran 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	(10026438)	-10026438	-	-
Year 1	3453240	-6573198	3453240	0.8696	3002817
Year 2	3980091	-2593107	7433331	0.7561	3009521
Year 3	3972067	1378960	11405398	0.6575	2611699
Year 4	3249950	4628910	14655348	0.5718	1858169
TOTAL					10482206

The Net NPV after 4 years is 455768

(10482206 - 10026438 )

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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	(10026438)	-10026438	-	-
Year 1	3453240	-6573198	3453240	0.8333	2877700
Year 2	3980091	-2593107	7433331	0.6944	2763952
Year 3	3972067	1378960	11405398	0.5787	2298650
Year 4	3249950	4628910	14655348	0.4823	1567298
TOTAL					9507600

The Net NPV after 4 years is -518838

At 20% discount rate the NPV is negative (9507600 - 10026438 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Adria Ferran 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 Adria Ferran has a NPV value higher than Zero then finance managers at Adria Ferran 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 Adria Ferran, then the stock price of the Adria Ferran 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 Adria Ferran 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 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 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.

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 Ferran AdriA? and elBulli's Transformation, Spanish Version

References & Further Readings

Marcel Planellas, Silviya Svejenova (2018), "Ferran AdriA? and elBulli's Transformation, Spanish Version Harvard Business Review Case Study. Published by HBR Publications.