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Spruce Lawn Farms: The IP Bean Opportunity 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 Spruce Lawn Farms: The IP Bean Opportunity case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Spruce Lawn Farms: The IP Bean Opportunity case study is a Harvard Business School (HBR) case study written by Mark B. Vandenbosch, Ron Anderson. The Spruce Lawn Farms: The IP Bean Opportunity (referred as “Soybeans Spruce” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Financial management.

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 Spruce Lawn Farms: The IP Bean Opportunity Case Study


The owner/operator of Spruce Lawn Farms, a cash crop farm located near London, Ontario, was thinking of expanding his operation to include identity-preserved soybeans and a grain dryer. The farm had been in operation for 12 years and consisted of 650 acres of owned land with plans to increase this through renting neighbouring fields to 2,000 acres by 2015. Current crops included genetically modified winter wheat, corn and soybeans, but given the growing backlash against genetically modified foods in Europe and Asia, he was considering adding certified identity-preserved soybeans as well. His back-of-the-envelope calculations seemed to indicate that the venture would pay off. However, when he approached his financial institution for a loan, they were concerned about how the new venture would change the farm's financial structure.


Case Authors : Mark B. Vandenbosch, Ron Anderson

Topic : Finance & Accounting

Related Areas : Financial management




Calculating Net Present Value (NPV) at 6% for Spruce Lawn Farms: The IP Bean Opportunity Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10009751) -10009751 - -
Year 1 3460055 -6549696 3460055 0.9434 3264203
Year 2 3963618 -2586078 7423673 0.89 3527606
Year 3 3946810 1360732 11370483 0.8396 3313818
Year 4 3222154 4582886 14592637 0.7921 2552248
TOTAL 14592637 12657874




The Net Present Value at 6% discount rate is 2648123

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. Internal Rate of Return
4. Net Present Value

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 Soybeans Spruce 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. Soybeans Spruce 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 Spruce Lawn Farms: The IP Bean Opportunity

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 Finance & Accounting 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 Soybeans Spruce 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 Soybeans Spruce 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 (10009751) -10009751 - -
Year 1 3460055 -6549696 3460055 0.8696 3008743
Year 2 3963618 -2586078 7423673 0.7561 2997065
Year 3 3946810 1360732 11370483 0.6575 2595092
Year 4 3222154 4582886 14592637 0.5718 1842277
TOTAL 10443177


The Net NPV after 4 years is 433426

(10443177 - 10009751 )








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 (10009751) -10009751 - -
Year 1 3460055 -6549696 3460055 0.8333 2883379
Year 2 3963618 -2586078 7423673 0.6944 2752513
Year 3 3946810 1360732 11370483 0.5787 2284034
Year 4 3222154 4582886 14592637 0.4823 1553894
TOTAL 9473819


The Net NPV after 4 years is -535932

At 20% discount rate the NPV is negative (9473819 - 10009751 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Soybeans Spruce 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 Soybeans Spruce has a NPV value higher than Zero then finance managers at Soybeans Spruce 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 Soybeans Spruce, then the stock price of the Soybeans Spruce 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 Soybeans Spruce 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.

Understanding of risks involved in the project.

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

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.






Negotiation Strategy of Spruce Lawn Farms: The IP Bean Opportunity

References & Further Readings

Mark B. Vandenbosch, Ron Anderson (2018), "Spruce Lawn Farms: The IP Bean Opportunity Harvard Business Review Case Study. Published by HBR Publications.


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