Crown Worldwide Group: Relocating in China Under the Closer Economic Partnership Arrangement 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 Crown Worldwide Group: Relocating in China Under the Closer Economic Partnership Arrangement case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Crown Worldwide Group: Relocating in China Under the Closer Economic Partnership Arrangement case study is a Harvard Business School (HBR) case study written by Michael J. Fratantuono. The Crown Worldwide Group: Relocating in China Under the Closer Economic Partnership Arrangement (referred as “Crown Cepa” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Operations management, Social responsibility, Strategy execution.

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 Crown Worldwide Group: Relocating in China Under the Closer Economic Partnership Arrangement Case Study

In June 2003, the governments of Hong Kong and the People's Republic of China signed the Closer Economic Partnership Arrangement (CEPA). CEPA outlined terms for the liberalization of trade in goods and services and enabled firms incorporated in Hong Kong to establish wholly owned businesses on the mainland. One firm that benefited from the liberalization was the Crown Worldwide Group. Founded by Jim Thompson in 1965, and based in Hong Kong since 1970, Crown had evolved into the world's largest privately held company providing relocations and records management services, and had become a significant player in the field of logistics. By 2003, the company had a global network of offices and warehouses in more than 100 cities on six continents. Following the signing of CEPA, Crown formulated a plan for building state-of-the-art warehouse/office complexes on the mainland. The first was to be in Shanghai, to be followed by a second in Beijing, and then others in several more cities. Crown was successful in the first phase of implementing its strategy: by August 2006, Shanghai employees had been working out of the new facility for more than a year. Meanwhile, Crown had located a plot of land in Beijing and had completed site preparations--but progress on construction had stalled due to unexpected delays in project registration approval from Beijing authorities. The delay raised the question: How best to proceed? As he considered his options, Thompson weighed tactical considerations and strategic concerns. Economic logic suggested the need to get the construction project back on track as quickly as possible. Nonetheless, he knew that any action had to be consistent with the core values he had cultivated at Crown, the reputation his company had earned as a world-class provider of logistics services, and Crown's plans for further expansion in China.

Case Authors : Michael J. Fratantuono

Topic : Global Business

Related Areas : Operations management, Social responsibility, Strategy execution

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Calculating Net Present Value (NPV) at 6% for Crown Worldwide Group: Relocating in China Under the Closer Economic Partnership Arrangement Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10022160)	-10022160	-	-
Year 1	3445580	-6576580	3445580	0.9434	3250547
Year 2	3975644	-2600936	7421224	0.89	3538309
Year 3	3960201	1359265	11381425	0.8396	3325061
Year 4	3246741	4606006	14628166	0.7921	2571723
TOTAL			14628166		12685640

The Net Present Value at 6% discount rate is 2663480

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 Crown Cepa 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. Crown Cepa 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 Crown Worldwide Group: Relocating in China Under the Closer Economic Partnership Arrangement

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 Crown Cepa 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 Crown Cepa 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	(10022160)	-10022160	-	-
Year 1	3445580	-6576580	3445580	0.8696	2996157
Year 2	3975644	-2600936	7421224	0.7561	3006158
Year 3	3960201	1359265	11381425	0.6575	2603896
Year 4	3246741	4606006	14628166	0.5718	1856335
TOTAL					10462546

The Net NPV after 4 years is 440386

(10462546 - 10022160 )

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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	(10022160)	-10022160	-	-
Year 1	3445580	-6576580	3445580	0.8333	2871317
Year 2	3975644	-2600936	7421224	0.6944	2760864
Year 3	3960201	1359265	11381425	0.5787	2291783
Year 4	3246741	4606006	14628166	0.4823	1565751
TOTAL					9489714

The Net NPV after 4 years is -532446

At 20% discount rate the NPV is negative (9489714 - 10022160 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Crown Cepa 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 Crown Cepa has a NPV value higher than Zero then finance managers at Crown Cepa 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 Crown Cepa, then the stock price of the Crown Cepa 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 Crown Cepa 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 can impact the cash flow of 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.

Understanding of risks involved in the project.

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

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 Crown Worldwide Group: Relocating in China Under the Closer Economic Partnership Arrangement

References & Further Readings

Michael J. Fratantuono (2018), "Crown Worldwide Group: Relocating in China Under the Closer Economic Partnership Arrangement Harvard Business Review Case Study. Published by HBR Publications.