Funskool India: Defend, Lead, and Counter Rivals 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 Funskool India: Defend, Lead, and Counter Rivals case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Funskool India: Defend, Lead, and Counter Rivals case study is a Harvard Business School (HBR) case study written by Rakesh Gupta, Valiaparampil Joseph Sebastian, Sandeep Puri, Kirthivasan Sathya Narayanan. The Funskool India: Defend, Lead, and Counter Rivals (referred as “Funskool 20b9” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Growth strategy, Manufacturing.

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 Funskool India: Defend, Lead, and Counter Rivals Case Study

In April 2017, the chief executive officer of Funskool India Limited (Funskool), was formulating a growth strategy to increase the company's annual revenues from 1.9 billion in 2016 to 5 billion by 2020. The Indian toy manufacturer had primarily catered to the local market while also exporting toys to developed markets. In 2006, the company expanded its line of products, set up an exclusive design department to develop new products, redesigned its advertising and promotional activities, and expanded into retail outlets. However, Chinese importers were upgrading and moving up the product segment ladder, where Funskool had a strong presence, and video games, which Funskool did not produce, were seeing exponential growth. How could Funskool augment the revenue obtained from the sale of its own brands? With Chinese competitors targeting consumers higher up the segment, should Funskool target customers in the lower economic levels? Should it enter the digital space to prevent a growth stall and catapult itself to the next stage in the growth cycle? The company needed to make some decisions and take steps to face these emerging challenges. Rakesh Gupta is affiliated with Institute of Management Technology, Ghaziabad. Sandeep Puri is affiliated with Asian Institute of Management.

Case Authors : Rakesh Gupta, Valiaparampil Joseph Sebastian, Sandeep Puri, Kirthivasan Sathya Narayanan

Topic : Global Business

Related Areas : Growth strategy, Manufacturing

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Calculating Net Present Value (NPV) at 6% for Funskool India: Defend, Lead, and Counter Rivals Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018750)	-10018750	-	-
Year 1	3459758	-6558992	3459758	0.9434	3263923
Year 2	3974552	-2584440	7434310	0.89	3537337
Year 3	3970746	1386306	11405056	0.8396	3333915
Year 4	3242272	4628578	14647328	0.7921	2568183
TOTAL			14647328		12703358

The Net Present Value at 6% discount rate is 2684608

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. Internal Rate of Return
2. Net Present Value
3. Profitability Index
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 Funskool 20b9 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. Funskool 20b9 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 Funskool India: Defend, Lead, and Counter Rivals

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 Global Business 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 Funskool 20b9 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 Funskool 20b9 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	(10018750)	-10018750	-	-
Year 1	3459758	-6558992	3459758	0.8696	3008485
Year 2	3974552	-2584440	7434310	0.7561	3005332
Year 3	3970746	1386306	11405056	0.6575	2610830
Year 4	3242272	4628578	14647328	0.5718	1853780
TOTAL					10478427

The Net NPV after 4 years is 459677

(10478427 - 10018750 )

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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	(10018750)	-10018750	-	-
Year 1	3459758	-6558992	3459758	0.8333	2883132
Year 2	3974552	-2584440	7434310	0.6944	2760106
Year 3	3970746	1386306	11405056	0.5787	2297885
Year 4	3242272	4628578	14647328	0.4823	1563596
TOTAL					9504718

The Net NPV after 4 years is -514032

At 20% discount rate the NPV is negative (9504718 - 10018750 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Funskool 20b9 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 Funskool 20b9 has a NPV value higher than Zero then finance managers at Funskool 20b9 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 Funskool 20b9, then the stock price of the Funskool 20b9 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 Funskool 20b9 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.

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

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.

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 Funskool India: Defend, Lead, and Counter Rivals

References & Further Readings

Rakesh Gupta, Valiaparampil Joseph Sebastian, Sandeep Puri, Kirthivasan Sathya Narayanan (2018), "Funskool India: Defend, Lead, and Counter Rivals Harvard Business Review Case Study. Published by HBR Publications.