Fitpass: Toward Democratizing Fitness 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 Fitpass: Toward Democratizing Fitness case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Fitpass: Toward Democratizing Fitness case study is a Harvard Business School (HBR) case study written by Anupama Prashar, Leena Ajit Kaushal. The Fitpass: Toward Democratizing Fitness (referred as “Fitpass Fitness” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Technology.

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 Fitpass: Toward Democratizing Fitness Case Study

It was July 2017 when the co-founders of Fitpass Business Ventures Private Ltd. (Fitpass), an online platform providing passes to fitness establishments in the Delhi-National Capital Region, were reflecting on the need for continuous innovation to stay relevant to their users. Launched in June 2015, the company intended to satisfy the unmet market need for flexible workout options at an affordable price for fitness-conscious Indian youth. The company's application, FITPASS, had been downloaded 100,000 times, and the company had gained 60,000 registered users and created a partner network of 1,500 fitness establishments in the region. Generating 100 per cent growth in month-on-month revenue, the company was among the leading platforms in this region. However, the online marketplace was becoming crowded with look-alike competitors, and the founders faced some tough questions: How could the company sustain its position in the current market? Was the company ready to move into other similar markets using the current business model and innovative capabilities? Anupama Prashar and Leena Ajit Kaushal are affiliated with Management Development Institute.

Case Authors : Anupama Prashar, Leena Ajit Kaushal

Topic : Technology & Operations

Related Areas : Technology

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Calculating Net Present Value (NPV) at 6% for Fitpass: Toward Democratizing Fitness Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10001646)	-10001646	-	-
Year 1	3446038	-6555608	3446038	0.9434	3250979
Year 2	3968113	-2587495	7414151	0.89	3531606
Year 3	3961188	1373693	11375339	0.8396	3325890
Year 4	3231782	4605475	14607121	0.7921	2559874
TOTAL			14607121		12668350

The Net Present Value at 6% discount rate is 2666704

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. Payback Period
3. Internal Rate of Return
4. Profitability Index

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 Fitpass Fitness 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. Fitpass Fitness 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 Fitpass: Toward Democratizing Fitness

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 Fitpass Fitness 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 Fitpass Fitness 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	(10001646)	-10001646	-	-
Year 1	3446038	-6555608	3446038	0.8696	2996555
Year 2	3968113	-2587495	7414151	0.7561	3000464
Year 3	3961188	1373693	11375339	0.6575	2604545
Year 4	3231782	4605475	14607121	0.5718	1847782
TOTAL					10449346

The Net NPV after 4 years is 447700

(10449346 - 10001646 )

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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	(10001646)	-10001646	-	-
Year 1	3446038	-6555608	3446038	0.8333	2871698
Year 2	3968113	-2587495	7414151	0.6944	2755634
Year 3	3961188	1373693	11375339	0.5787	2292354
Year 4	3231782	4605475	14607121	0.4823	1558537
TOTAL					9478223

The Net NPV after 4 years is -523423

At 20% discount rate the NPV is negative (9478223 - 10001646 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Fitpass Fitness 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 Fitpass Fitness has a NPV value higher than Zero then finance managers at Fitpass Fitness 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 Fitpass Fitness, then the stock price of the Fitpass Fitness 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 Fitpass Fitness 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 Fitpass: Toward Democratizing Fitness

References & Further Readings

Anupama Prashar, Leena Ajit Kaushal (2018), "Fitpass: Toward Democratizing Fitness Harvard Business Review Case Study. Published by HBR Publications.