Brooks Sports: Competing against the Giants 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 Brooks Sports: Competing against the Giants case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Brooks Sports: Competing against the Giants case study is a Harvard Business School (HBR) case study written by Wiboon Kittilaksanawong, Andrew Jiro Poplawski. The Brooks Sports: Competing against the Giants (referred as “Brooks Running” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, 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

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Case Description of Brooks Sports: Competing against the Giants Case Study

Brooks Sports, Inc. (Brooks) strove to inspire and promote an active lifestyle through its innovative gear, enabling its customers to run longer, farther, and faster. The shoe company had endured a number of growths and declines in its 100 years of operations. Nearly bankrupt by 2000 because of its attempt to compete with diversified athletic brands, Brooks had finally found a strategy to compete in the sports market. Operating as an independent subsidiary of Berkshire Hathaway Inc., Brooks focused entirely on the niche running market, transforming into a brand that generated over $500 million in 2014. Now Brooks had set its sights on becoming a $1 billion brand by 2020. In the past, few companies had focused on the small but growing running industry; however, with the running market becoming increasingly competitive, would Brooks's runner-focused strategy carry the company to its $1 billion goal by 2020, or would it be forced to shift back to a diversified approach as the running market became more crowded? Wiboon Kittilaksanawong is affiliated with Saitama University. Andrew Jiro Poplawski is affiliated with Nagoya University of Commerce & Business.

Case Authors : Wiboon Kittilaksanawong, Andrew Jiro Poplawski

Topic : Innovation & Entrepreneurship

Related Areas : Risk management

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Calculating Net Present Value (NPV) at 6% for Brooks Sports: Competing against the Giants Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10017429)	-10017429	-	-
Year 1	3450508	-6566921	3450508	0.9434	3255196
Year 2	3972780	-2594141	7423288	0.89	3535760
Year 3	3935932	1341791	11359220	0.8396	3304684
Year 4	3226607	4568398	14585827	0.7921	2555775
TOTAL			14585827		12651416

The Net Present Value at 6% discount rate is 2633987

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

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 Brooks Running 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. Brooks Running 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 Brooks Sports: Competing against the Giants

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 Brooks Running 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 Brooks Running 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	(10017429)	-10017429	-	-
Year 1	3450508	-6566921	3450508	0.8696	3000442
Year 2	3972780	-2594141	7423288	0.7561	3003992
Year 3	3935932	1341791	11359220	0.6575	2587939
Year 4	3226607	4568398	14585827	0.5718	1844823
TOTAL					10437196

The Net NPV after 4 years is 419767

(10437196 - 10017429 )

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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	(10017429)	-10017429	-	-
Year 1	3450508	-6566921	3450508	0.8333	2875423
Year 2	3972780	-2594141	7423288	0.6944	2758875
Year 3	3935932	1341791	11359220	0.5787	2277738
Year 4	3226607	4568398	14585827	0.4823	1556041
TOTAL					9468078

The Net NPV after 4 years is -549351

At 20% discount rate the NPV is negative (9468078 - 10017429 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Brooks Running 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 Brooks Running has a NPV value higher than Zero then finance managers at Brooks Running 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 Brooks Running, then the stock price of the Brooks Running 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 Brooks Running 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.

Understanding of risks involved in 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 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.

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 Brooks Sports: Competing against the Giants

References & Further Readings

Wiboon Kittilaksanawong, Andrew Jiro Poplawski (2018), "Brooks Sports: Competing against the Giants Harvard Business Review Case Study. Published by HBR Publications.