Drawn and Quarterly 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 Drawn and Quarterly case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Drawn and Quarterly case study is a Harvard Business School (HBR) case study written by Fernando Olivera. The Drawn and Quarterly (referred as “Comic Quarterly” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Organizational culture.

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 Drawn and Quarterly Case Study

The founder and only employee of Montreal-based Drawn and Quarterly, a company that publishes comic books and graphic novels, wondered whether there were changes he should make in how he ran his company. He loved his job, he was working with excellent cartoonists, and he enjoyed being his own boss. He wanted to invest in new projects, but his ability to do so depended on getting enough revenue from sales. He recently made a substantial investment in the publication of an anthology of international comics and knew this investment could put the company at risk. There were many factors for him to consider in planning the growth of this small company: management preferences in strategic growth, marketing in entrepreneurial firms, the comic book industry, and the management of small companies in cultural industries.

Case Authors : Fernando Olivera

Topic : Innovation & Entrepreneurship

Related Areas : Organizational culture

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Calculating Net Present Value (NPV) at 6% for Drawn and Quarterly Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10019533)	-10019533	-	-
Year 1	3446835	-6572698	3446835	0.9434	3251731
Year 2	3967930	-2604768	7414765	0.89	3531444
Year 3	3962592	1357824	11377357	0.8396	3327069
Year 4	3229702	4587526	14607059	0.7921	2558226
TOTAL			14607059		12668470

The Net Present Value at 6% discount rate is 2648937

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. 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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Comic Quarterly 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 Comic Quarterly have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Drawn and Quarterly

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 Innovation & Entrepreneurship 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 Comic Quarterly 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 Comic Quarterly 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	(10019533)	-10019533	-	-
Year 1	3446835	-6572698	3446835	0.8696	2997248
Year 2	3967930	-2604768	7414765	0.7561	3000325
Year 3	3962592	1357824	11377357	0.6575	2605469
Year 4	3229702	4587526	14607059	0.5718	1846593
TOTAL					10449634

The Net NPV after 4 years is 430101

(10449634 - 10019533 )

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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	(10019533)	-10019533	-	-
Year 1	3446835	-6572698	3446835	0.8333	2872363
Year 2	3967930	-2604768	7414765	0.6944	2755507
Year 3	3962592	1357824	11377357	0.5787	2293167
Year 4	3229702	4587526	14607059	0.4823	1557534
TOTAL					9478570

The Net NPV after 4 years is -540963

At 20% discount rate the NPV is negative (9478570 - 10019533 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Comic Quarterly 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 Comic Quarterly has a NPV value higher than Zero then finance managers at Comic Quarterly 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 Comic Quarterly, then the stock price of the Comic Quarterly 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 Comic Quarterly 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 will be a multi year spillover effect of various taxation regulations.

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.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Understanding of risks involved in 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.

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Negotiation Strategy of Drawn and Quarterly

References & Further Readings

Fernando Olivera (2018), "Drawn and Quarterly Harvard Business Review Case Study. Published by HBR Publications.