TeeGolf Company: To Exit or Not to Exit - Team 1 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 TeeGolf Company: To Exit or Not to Exit - Team 1 case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. TeeGolf Company: To Exit or Not to Exit - Team 1 case study is a Harvard Business School (HBR) case study written by Yael Grushka-Cockayne, Nick Molloy. The TeeGolf Company: To Exit or Not to Exit - Team 1 (referred as “Teegolf Alexander” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Analytics, Mergers & acquisitions, Negotiations.

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 TeeGolf Company: To Exit or Not to Exit - Team 1 Case Study

Kris Alexander is a newly appointed partner at the private equity firm Kohlberg & Co. Alexander is preparing an exit proposal for one of Kohlberg's portfolio companies, the TeeGolf Company. Alexander believes that TeeGolf has a great opportunity of selling for a purchase price that would achieve a return equal to or greater than the firm's target IRR of 25%. However, Alexander was concerned about the viability of the sale. Specifically, he wondered: would strategic buyers, who would pay premiums to financial sponsors, actually be interested in this business? How would the firm negotiate amongst potential buyers if several submitted bids? What if there was only one buyer interested? Had Kohlberg's valuation accounted for a potential recession? How should he account for the investment banking adviser fees in his recommendation to sell? To answer these questions, students will be required to evaluate different exit strategies from multiple perspectives, understand how to work with a leveraged buyout analysis, a discounted cash flow, and how to add in the effects of synergies. A negotiation exercise between Kohlberg and two potential buyers, private equity firm Leonard Green Partners and a strategic buyer GoGolf, can support the learnings around asymmetric information, ZOPA, and BATNA. This case works well in a module covering firm valuations and financial negotiations. It would complement the HBS note on negotiations and cases such as Kelly Solar and Wrigley/Mars.

Case Authors : Yael Grushka-Cockayne, Nick Molloy

Topic : Leadership & Managing People

Related Areas : Analytics, Mergers & acquisitions, Negotiations

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Calculating Net Present Value (NPV) at 6% for TeeGolf Company: To Exit or Not to Exit - Team 1 Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018258)	-10018258	-	-
Year 1	3446471	-6571787	3446471	0.9434	3251388
Year 2	3964190	-2607597	7410661	0.89	3528115
Year 3	3940386	1332789	11351047	0.8396	3308424
Year 4	3242686	4575475	14593733	0.7921	2568511
TOTAL			14593733		12656438

The Net Present Value at 6% discount rate is 2638180

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 Teegolf Alexander 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. Teegolf Alexander 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 TeeGolf Company: To Exit or Not to Exit - Team 1

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 Leadership & Managing People 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 Teegolf Alexander 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 Teegolf Alexander 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	(10018258)	-10018258	-	-
Year 1	3446471	-6571787	3446471	0.8696	2996931
Year 2	3964190	-2607597	7410661	0.7561	2997497
Year 3	3940386	1332789	11351047	0.6575	2590868
Year 4	3242686	4575475	14593733	0.5718	1854016
TOTAL					10439312

The Net NPV after 4 years is 421054

(10439312 - 10018258 )

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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	(10018258)	-10018258	-	-
Year 1	3446471	-6571787	3446471	0.8333	2872059
Year 2	3964190	-2607597	7410661	0.6944	2752910
Year 3	3940386	1332789	11351047	0.5787	2280316
Year 4	3242686	4575475	14593733	0.4823	1563795
TOTAL					9469080

The Net NPV after 4 years is -549178

At 20% discount rate the NPV is negative (9469080 - 10018258 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Teegolf Alexander 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 Teegolf Alexander has a NPV value higher than Zero then finance managers at Teegolf Alexander 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 Teegolf Alexander, then the stock price of the Teegolf Alexander 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 Teegolf Alexander 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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in 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.

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 TeeGolf Company: To Exit or Not to Exit - Team 1

References & Further Readings

Yael Grushka-Cockayne, Nick Molloy (2018), "TeeGolf Company: To Exit or Not to Exit - Team 1 Harvard Business Review Case Study. Published by HBR Publications.