West Marine: Driving Growth Through Shipshape Supply Chain 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 West Marine: Driving Growth Through Shipshape Supply Chain Management case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. West Marine: Driving Growth Through Shipshape Supply Chain Management case study is a Harvard Business School (HBR) case study written by Hau Lee, Lyn Denend. The West Marine: Driving Growth Through Shipshape Supply Chain Management (referred as “Marine West” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Growth strategy, International business, Mergers & acquisitions, Supply chain.

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 West Marine: Driving Growth Through Shipshape Supply Chain Management Case Study

In January 2003, West Marine (the nation's largest boating supply retailer) was on the verge of acquiring its biggest competitor, BoatU.S. Several years earlier, the company had acquired E&B Marine, another boating supply company of a similar size. However, that transaction proved to be too much for the organization to bear. Having nearly doubled its number of stores overnight, West Marine's systems and processes, as well as the experience level of its management team, could not withstand the rapid growth. West Marine's supply chain was especially hard-hit: The company was unable to keep all 72 West Marine and 63 E&B Marine stores amply stocked during the critical peak season. Following the E&B Marine transaction, the company charted a new course, bringing in a deeply experienced management team, initiating a significant cultural change, and repairing systems and processes across the company. On the eve of another major acquisition, West Marine was proud of all that the company had accomplished through its collaborative planning, forecasting, and replenishment program, particularly in the supply chain arena. As the company prepared to ramp up its growth engine again on its way to becoming a $1 billion business, West Marine's executive team wondered what "soft spots" might be discovered within its new and improved infrastructure.

Case Authors : Hau Lee, Lyn Denend

Topic : Technology & Operations

Related Areas : Growth strategy, International business, Mergers & acquisitions, Supply chain

Calculating Net Present Value (NPV) at 6% for West Marine: Driving Growth Through Shipshape Supply Chain Management Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10010113) -10010113 - -
Year 1 3467045 -6543068 3467045 0.9434 3270797
Year 2 3965937 -2577131 7432982 0.89 3529670
Year 3 3958880 1381749 11391862 0.8396 3323952
Year 4 3231507 4613256 14623369 0.7921 2559656
TOTAL 14623369 12684075

The Net Present Value at 6% discount rate is 2673962

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. 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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Marine West 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 Marine West 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 West Marine: Driving Growth Through Shipshape Supply Chain 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 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 Marine West 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 Marine West 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 %
Cash Flows
Year 0 (10010113) -10010113 - -
Year 1 3467045 -6543068 3467045 0.8696 3014822
Year 2 3965937 -2577131 7432982 0.7561 2998818
Year 3 3958880 1381749 11391862 0.6575 2603028
Year 4 3231507 4613256 14623369 0.5718 1847625
TOTAL 10464292

The Net NPV after 4 years is 454179

(10464292 - 10010113 )

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 %
Cash Flows
Year 0 (10010113) -10010113 - -
Year 1 3467045 -6543068 3467045 0.8333 2889204
Year 2 3965937 -2577131 7432982 0.6944 2754123
Year 3 3958880 1381749 11391862 0.5787 2291019
Year 4 3231507 4613256 14623369 0.4823 1558404
TOTAL 9492750

The Net NPV after 4 years is -517363

At 20% discount rate the NPV is negative (9492750 - 10010113 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Marine West 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 Marine West has a NPV value higher than Zero then finance managers at Marine West 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 Marine West, then the stock price of the Marine West 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 Marine West 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.

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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

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.

References & Further Readings

Hau Lee, Lyn Denend (2018), "West Marine: Driving Growth Through Shipshape Supply Chain Management Harvard Business Review Case Study. Published by HBR Publications.