Michaels Craft Stores: Integrated Channel Management and Vendor-Retailer Relations 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 Michaels Craft Stores: Integrated Channel Management and Vendor-Retailer Relations case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Michaels Craft Stores: Integrated Channel Management and Vendor-Retailer Relations case study is a Harvard Business School (HBR) case study written by Anne Coughlan, Lindsey M. Piegza. The Michaels Craft Stores: Integrated Channel Management and Vendor-Retailer Relations (referred as “Michaels Sophistication” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Marketing, Operations management.

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 Michaels Craft Stores: Integrated Channel Management and Vendor-Retailer Relations Case Study

Michaels Craft Stores is the largest arts and crafts retailer in the United States and in the world. Its CEO, Michael Rouleau, wants to expand the chain to 1,000 stores by 2006. The key constraint is the lack of sophistication among Michaels' supplier base, which is made up of over 1,000 suppliers, many of which are small, creative companies with little computer or logistics knowledge. As a result, the cost of running Michaels' supply chain is high. Describes the company's efforts to build the sophistication of its suppliers through educational Vendor Flow Training courses that teach suppliers how to adopt state-of-the-art practices for improved efficiency in supplying their channel.

Case Authors : Anne Coughlan, Lindsey M. Piegza

Topic : Technology & Operations

Related Areas : Marketing, Operations management

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Calculating Net Present Value (NPV) at 6% for Michaels Craft Stores: Integrated Channel Management and Vendor-Retailer Relations Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10015104)	-10015104	-	-
Year 1	3466288	-6548816	3466288	0.9434	3270083
Year 2	3955846	-2592970	7422134	0.89	3520689
Year 3	3942421	1349451	11364555	0.8396	3310133
Year 4	3222151	4571602	14586706	0.7921	2552245
TOTAL			14586706		12653150

The Net Present Value at 6% discount rate is 2638046

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. Net Present Value
2. Profitability Index
3. Internal Rate of Return
4. Payback Period

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 Michaels Sophistication 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. Michaels Sophistication 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 Michaels Craft Stores: Integrated Channel Management and Vendor-Retailer Relations

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 Technology & Operations 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 Michaels Sophistication 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 Michaels Sophistication 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	(10015104)	-10015104	-	-
Year 1	3466288	-6548816	3466288	0.8696	3014163
Year 2	3955846	-2592970	7422134	0.7561	2991188
Year 3	3942421	1349451	11364555	0.6575	2592206
Year 4	3222151	4571602	14586706	0.5718	1842275
TOTAL					10439832

The Net NPV after 4 years is 424728

(10439832 - 10015104 )

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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	(10015104)	-10015104	-	-
Year 1	3466288	-6548816	3466288	0.8333	2888573
Year 2	3955846	-2592970	7422134	0.6944	2747115
Year 3	3942421	1349451	11364555	0.5787	2281494
Year 4	3222151	4571602	14586706	0.4823	1553892
TOTAL					9471075

The Net NPV after 4 years is -544029

At 20% discount rate the NPV is negative (9471075 - 10015104 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Michaels Sophistication 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 Michaels Sophistication has a NPV value higher than Zero then finance managers at Michaels Sophistication 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 Michaels Sophistication, then the stock price of the Michaels Sophistication 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 Michaels Sophistication 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 –

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.

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.

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Negotiation Strategy of Michaels Craft Stores: Integrated Channel Management and Vendor-Retailer Relations

References & Further Readings

Anne Coughlan, Lindsey M. Piegza (2018), "Michaels Craft Stores: Integrated Channel Management and Vendor-Retailer Relations Harvard Business Review Case Study. Published by HBR Publications.