×




Colombina S.A.: Entering the Ice Cream Market 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 Colombina S.A.: Entering the Ice Cream Market case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Colombina S.A.: Entering the Ice Cream Market case study is a Harvard Business School (HBR) case study written by Enrique Ramirez, Juanita Cajiao. The Colombina S.A.: Entering the Ice Cream Market (referred as “Cream Ice” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, Marketing.

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 Colombina S.A.: Entering the Ice Cream Market Case Study


In March 2017, the vice-president of the ice cream division at Colombina S.A. (Colombina), was in her office at the company's headquarters in Cali, Colombia. She was reviewing the growth figures for the company's ice cream business, for which she was accountable. The sales target set for the company in 2010 was US$1 billion by 2020, and the ice cream segment would play a fundamental role in reaching that target. The vice-president remembered what Colombina's chief executive officer had told employees the year before at the last strategic planning meeting: "It is simple; in order to reach the sales target, we must continue to do three things: achieve organic growth of the businesses we already have, open new markets or new businesses, and acquire companies with which we can generate synergies with our ongoing businesses." Despite having invoiced over $40 million in ice cream in 2016, a growth of 1 per cent over 2015, the vice-president was aware of the challenge this strategic guideline meant for her category, which led her to consider options for increasing sales and profits. What market opportunities should the ice cream division exploit? What channels should it grow? Should particular channels be grown more than others? Should the product portfolio be expanded? The authors Enrique Ramirez and Juanita Cajiao Saenz are affiliated with Universidad ICESI.


Case Authors : Enrique Ramirez, Juanita Cajiao

Topic : Sales & Marketing

Related Areas : Marketing




Calculating Net Present Value (NPV) at 6% for Colombina S.A.: Entering the Ice Cream Market Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10027569) -10027569 - -
Year 1 3469137 -6558432 3469137 0.9434 3272771
Year 2 3978994 -2579438 7448131 0.89 3541290
Year 3 3974612 1395174 11422743 0.8396 3337161
Year 4 3240389 4635563 14663132 0.7921 2566692
TOTAL 14663132 12717914




The Net Present Value at 6% discount rate is 2690345

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. Net Present Value
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 Cream Ice 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. Cream Ice shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of Colombina S.A.: Entering the Ice Cream Market

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 Sales & Marketing 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 Cream Ice 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 Cream Ice 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 (10027569) -10027569 - -
Year 1 3469137 -6558432 3469137 0.8696 3016641
Year 2 3978994 -2579438 7448131 0.7561 3008691
Year 3 3974612 1395174 11422743 0.6575 2613372
Year 4 3240389 4635563 14663132 0.5718 1852703
TOTAL 10491407


The Net NPV after 4 years is 463838

(10491407 - 10027569 )








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 (10027569) -10027569 - -
Year 1 3469137 -6558432 3469137 0.8333 2890948
Year 2 3978994 -2579438 7448131 0.6944 2763190
Year 3 3974612 1395174 11422743 0.5787 2300123
Year 4 3240389 4635563 14663132 0.4823 1562688
TOTAL 9516948


The Net NPV after 4 years is -510621

At 20% discount rate the NPV is negative (9516948 - 10027569 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Cream Ice 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 Cream Ice has a NPV value higher than Zero then finance managers at Cream Ice 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 Cream Ice, then the stock price of the Cream Ice 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 Cream Ice 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.

Understanding of risks involved in the project.

What can impact the cash flow of 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.

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.






Negotiation Strategy of Colombina S.A.: Entering the Ice Cream Market

References & Further Readings

Enrique Ramirez, Juanita Cajiao (2018), "Colombina S.A.: Entering the Ice Cream Market Harvard Business Review Case Study. Published by HBR Publications.


Metro Inc. SWOT Analysis / TOWS Matrix

Services , Retail (Grocery)


RespireRx Pharma SWOT Analysis / TOWS Matrix

Healthcare , Biotechnology & Drugs


Annaly Capital Pref G SWOT Analysis / TOWS Matrix

Financial , Misc. Financial Services


SMT Scharf AG SWOT Analysis / TOWS Matrix

Capital Goods , Constr. & Agric. Machinery


Landore SWOT Analysis / TOWS Matrix

Basic Materials , Gold & Silver


Challenger Tech SWOT Analysis / TOWS Matrix

Services , Retail (Technology)


Sheela Foam SWOT Analysis / TOWS Matrix

Consumer Cyclical , Furniture & Fixtures