Powerwater Beverages 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 Powerwater Beverages case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Powerwater Beverages case study is a Harvard Business School (HBR) case study written by Jeffrey P. Shay, Bambi Douma, Tony Crawford, Josh Herbold. The Powerwater Beverages (referred as “Oxygenated Powerwater” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Financial analysis, Financial 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 Powerwater Beverages Case Study

Describes the early stage development of PowerWater Beverages, a company poised to capitalize on the growing U.S. consumer demand for bottled water and, more specifically, for "pure water". The investors successfully negotiated the exclusive rights and interest in a trade secret and industrial design to produce and distribute a pure distilled oxygenated water, secured commitments from independent representatives who comprised the company's national sales force, and signed contracts with co-packers, suppliers, and distributors. As the CEO, Kent Mawhinney, prepares for a board meeting, he must determine whether his CPA's estimated capital requirements are correct, calculate what the pre and post money valuation for the company, analyze the impact of proposed alternatives, reassess the strength of the opportunity to see if it still makes sense to pursue it, and determine whether other opportunities for PowerWater's distilled, oxygenated water product exist beyond the general market that the core product will target. This case is intended for undergraduate and graduate entrepreneurship, entrepreneurial finance, and finance courses. We realize that this presents a wide range of potential applications for the case but believe that the rich data provided in the case provides adequate information for the case to add value to the aforementioned courses. Professors using this case should have already or should intend to provide students with lectures and assigned readings on how to analyze the feasibility of entrepreneurial ventures. This should include the appropriate tools and models for conducting analyses from an entrepreneurial as well as financial valuation perspective. The author has used the work of Jeffry Timmons and Michael Porter as the basis for discussing this case.

Case Authors : Jeffrey P. Shay, Bambi Douma, Tony Crawford, Josh Herbold

Topic : Innovation & Entrepreneurship

Related Areas : Financial analysis, Financial management

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Calculating Net Present Value (NPV) at 6% for Powerwater Beverages Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012948)	-10012948	-	-
Year 1	3458972	-6553976	3458972	0.9434	3263181
Year 2	3968837	-2585139	7427809	0.89	3532251
Year 3	3960248	1375109	11388057	0.8396	3325101
Year 4	3247880	4622989	14635937	0.7921	2572625
TOTAL			14635937		12693158

The Net Present Value at 6% discount rate is 2680210

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Oxygenated Powerwater 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 Oxygenated Powerwater 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 Powerwater Beverages

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 Oxygenated Powerwater 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 Oxygenated Powerwater 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	(10012948)	-10012948	-	-
Year 1	3458972	-6553976	3458972	0.8696	3007802
Year 2	3968837	-2585139	7427809	0.7561	3001011
Year 3	3960248	1375109	11388057	0.6575	2603927
Year 4	3247880	4622989	14635937	0.5718	1856986
TOTAL					10469726

The Net NPV after 4 years is 456778

(10469726 - 10012948 )

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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	(10012948)	-10012948	-	-
Year 1	3458972	-6553976	3458972	0.8333	2882477
Year 2	3968837	-2585139	7427809	0.6944	2756137
Year 3	3960248	1375109	11388057	0.5787	2291810
Year 4	3247880	4622989	14635937	0.4823	1566300
TOTAL					9496724

The Net NPV after 4 years is -516224

At 20% discount rate the NPV is negative (9496724 - 10012948 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Oxygenated Powerwater 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 Oxygenated Powerwater has a NPV value higher than Zero then finance managers at Oxygenated Powerwater 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 Oxygenated Powerwater, then the stock price of the Oxygenated Powerwater 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 Oxygenated Powerwater 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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

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.

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 Powerwater Beverages

References & Further Readings

Jeffrey P. Shay, Bambi Douma, Tony Crawford, Josh Herbold (2018), "Powerwater Beverages Harvard Business Review Case Study. Published by HBR Publications.