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Diageo and Mey Icki: Turkish Delight or Turkish Hangover? 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 Diageo and Mey Icki: Turkish Delight or Turkish Hangover? case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Diageo and Mey Icki: Turkish Delight or Turkish Hangover? case study is a Harvard Business School (HBR) case study written by Dante Roscini, Gamze Yucaoglu. The Diageo and Mey Icki: Turkish Delight or Turkish Hangover? (referred as “Icki Mey” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Financial analysis, Policy, Risk 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 Diageo and Mey Icki: Turkish Delight or Turkish Hangover? Case Study


In September 2013, two years after its $2.1 billion acquisition of Mey Icki Sanayi ve Ticaret AS (Mey Icki), the principal spirits company in Turkey specializing in the local beverage, raki, Diageo, the world's leading premium drinks company, was concerned about new legislation approved by the Turkish parliament prohibiting marketing and restricting the places and times at which alcoholic beverages could be sold. Diageo's Mey Icki investment in 2011 was the company's biggest acquisition in more than a decade. Having been caught off guard by the 2013 legislative changes, the Diageo management found itself needing to justify its $2.1 billion valuation, given that Diageo had acquired Mey Icki in 2011 from TPG for three times TPG's purchase price in 2006. Investors as well as analysts were questioning the over seven times value increase in Mey Icki since its privatization in 2003. Menezes, new to the CEO post, found himself increasingly overwhelmed by these issues. Had Diageo underestimated the uncertainties in the Turkish market? Would Diageo, with its broad range of brands, geographical spread, and significant financial resources be able to adapt to the changing environment and recoup its vast investment in Turkey? The case describes the forces that affect investment circumstances in emerging markets, raising the issue of how to best manage and prepare for risks. The case provides the context for the students to identify the potential elements that companies could face when investing in emerging markets where rules, legislation, and taxation can change and thus affect investment outcomes. The case challenges the students to ponder how companies should think about when investing in volatile markets and what it takes for them to succeed under uncertain and shifting circumstances.


Case Authors : Dante Roscini, Gamze Yucaoglu

Topic : Global Business

Related Areas : Financial analysis, Policy, Risk management




Calculating Net Present Value (NPV) at 6% for Diageo and Mey Icki: Turkish Delight or Turkish Hangover? Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10015125) -10015125 - -
Year 1 3468330 -6546795 3468330 0.9434 3272009
Year 2 3981327 -2565468 7449657 0.89 3543367
Year 3 3945566 1380098 11395223 0.8396 3312773
Year 4 3241274 4621372 14636497 0.7921 2567393
TOTAL 14636497 12695542


The Net Present Value at 6% discount rate is 2680417

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. Payback Period
2. Internal Rate of Return
3. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Icki Mey shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Icki Mey have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.




Formula and Steps to Calculate Net Present Value (NPV) of Diageo and Mey Icki: Turkish Delight or Turkish Hangover?

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 Icki Mey 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 Icki Mey 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 (10015125) -10015125 - -
Year 1 3468330 -6546795 3468330 0.8696 3015939
Year 2 3981327 -2565468 7449657 0.7561 3010455
Year 3 3945566 1380098 11395223 0.6575 2594274
Year 4 3241274 4621372 14636497 0.5718 1853209
TOTAL 10473877


The Net NPV after 4 years is 458752

(10473877 - 10015125 )






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 (10015125) -10015125 - -
Year 1 3468330 -6546795 3468330 0.8333 2890275
Year 2 3981327 -2565468 7449657 0.6944 2764810
Year 3 3945566 1380098 11395223 0.5787 2283314
Year 4 3241274 4621372 14636497 0.4823 1563114
TOTAL 9501513


The Net NPV after 4 years is -513612

At 20% discount rate the NPV is negative (9501513 - 10015125 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Icki Mey 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 Icki Mey has a NPV value higher than Zero then finance managers at Icki Mey 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 Icki Mey, then the stock price of the Icki Mey 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 Icki Mey 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 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.

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.




References & Further Readings

Dante Roscini, Gamze Yucaoglu (2018), "Diageo and Mey Icki: Turkish Delight or Turkish Hangover? Harvard Business Review Case Study. Published by HBR Publications.