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Priceline WebHouse Club 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 Priceline WebHouse Club case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Priceline WebHouse Club case study is a Harvard Business School (HBR) case study written by Thomas R. Eisenmann, Jon K. Rust. The Priceline WebHouse Club (referred as “Webhouse Priceline” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Disruptive innovation, Entrepreneurship, Internet.

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 Priceline WebHouse Club Case Study


This case is available in only hard copy format (HBP does not have digital distribution rights to the content). As a result, a digital Educator Copy of the case is not available through this web site.Priceline empowered consumers to "name their own price" for airline tickets and hotel rooms; then it shopped these offers to marketers. Priceline's founder Jay Walker described the resulting transactions as a new ecosystem, that helped consumers realize lower prices while allowing marketers to turn excess inventory into profit and, in so doing, price discriminate without damaging their brands or their published prices. Airline tickets and hotel reservations were only the starting point for Priceline, however. By the end of 1999, Priceline had made inroads into the mortgage, new car sales, and car rental businesses. In November, Walker launched Priceline WebHouse Club to bring the "name-your-price" concept to groceries, with plans to eventually scale WebHouse to include almost every type of retailing. Several pressing issues confront the Priceline WebHouse management team in this case. First, the company had yet to close a deal with any major brand manufacturer. Thus, to satisfy customers, WebHouse subsidized member savings out of its own coffers, which, combined with early consumer success, led to significant losses and cash burn. To continue its customer acquisition, Walker projected that $200 million to $500 million in additional capital would be necessary. Meanwhile, the company confronted questions about where and how quickly it should expand.


Case Authors : Thomas R. Eisenmann, Jon K. Rust

Topic : Innovation & Entrepreneurship

Related Areas : Disruptive innovation, Entrepreneurship, Internet




Calculating Net Present Value (NPV) at 6% for Priceline WebHouse Club Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10019425) -10019425 - -
Year 1 3451792 -6567633 3451792 0.9434 3256408
Year 2 3971764 -2595869 7423556 0.89 3534856
Year 3 3960363 1364494 11383919 0.8396 3325197
Year 4 3241743 4606237 14625662 0.7921 2567764
TOTAL 14625662 12684225




The Net Present Value at 6% discount rate is 2664800

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. Net Present Value
3. Profitability Index
4. Internal Rate of Return

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 Webhouse Priceline 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. Webhouse Priceline 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 Priceline WebHouse Club

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 Webhouse Priceline 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 Webhouse Priceline 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 (10019425) -10019425 - -
Year 1 3451792 -6567633 3451792 0.8696 3001558
Year 2 3971764 -2595869 7423556 0.7561 3003224
Year 3 3960363 1364494 11383919 0.6575 2604003
Year 4 3241743 4606237 14625662 0.5718 1853477
TOTAL 10462262


The Net NPV after 4 years is 442837

(10462262 - 10019425 )








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 (10019425) -10019425 - -
Year 1 3451792 -6567633 3451792 0.8333 2876493
Year 2 3971764 -2595869 7423556 0.6944 2758169
Year 3 3960363 1364494 11383919 0.5787 2291877
Year 4 3241743 4606237 14625662 0.4823 1563341
TOTAL 9489880


The Net NPV after 4 years is -529545

At 20% discount rate the NPV is negative (9489880 - 10019425 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Webhouse Priceline 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 Webhouse Priceline has a NPV value higher than Zero then finance managers at Webhouse Priceline 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 Webhouse Priceline, then the stock price of the Webhouse Priceline 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 Webhouse Priceline 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 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.

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 Priceline WebHouse Club

References & Further Readings

Thomas R. Eisenmann, Jon K. Rust (2018), "Priceline WebHouse Club Harvard Business Review Case Study. Published by HBR Publications.


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