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NPV: OXO International Net Present Value Case Analysis
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OXO International 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 OXO International case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. OXO International case study is a Harvard Business School (HBR) case study written by H. Kent Bowen, Marilyn E. Matis, Sylvie Ryckebusch. The OXO International (referred as “Housewares Oxo” from here on) case study provides evaluation & decision scenario in field of Innovation & Entrepreneurship. It also touches upon business topics such as - Value proposition, Entrepreneurial management, Supply chain.

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 OXO International Case Study


OXO, a kitchen tools and gadgets company, was started by a businessman who had 30 years of experience in the housewares industry. With his wife and son as founders, he creates a new niche in the gadgets industry for high-end gourmet stores. The company has headquarters in New York City, but it outsources product design to a NYC industrial design firm, manufacturing to Asia, and warehousing to a site in Connecticut in order to manage start-up costs and growth. Because of the veteran businessman's reputation and industry sense, the company grows quickly and in 1992 is sold for $6.2 million to a large housewares distributor, General Housewares. The original owners stay on as consultants to the parent company and decide to turn over management of the company to a Harvard MBA who also has extensive industrial design experience. Innovative product design is the key to OXO's success, and the company has worked exclusively with one design firm based on royalties of sold products. The new managing director initiates new product category programs for the bathroom, the garden, and home baking. He must coordinate the outsourcing of the design and development function.


Case Authors : H. Kent Bowen, Marilyn E. Matis, Sylvie Ryckebusch

Topic : Innovation & Entrepreneurship

Related Areas : Entrepreneurial management, Supply chain




Calculating Net Present Value (NPV) at 6% for OXO International Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10025609) -10025609 - -
Year 1 3468557 -6557052 3468557 0.9434 3272224
Year 2 3968378 -2588674 7436935 0.89 3531842
Year 3 3942486 1353812 11379421 0.8396 3310187
Year 4 3246962 4600774 14626383 0.7921 2571898
TOTAL 14626383 12686151


The Net Present Value at 6% discount rate is 2660542

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

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 Housewares Oxo 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. Housewares Oxo 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 OXO International

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 Housewares Oxo 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 Housewares Oxo 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 (10025609) -10025609 - -
Year 1 3468557 -6557052 3468557 0.8696 3016137
Year 2 3968378 -2588674 7436935 0.7561 3000664
Year 3 3942486 1353812 11379421 0.6575 2592249
Year 4 3246962 4600774 14626383 0.5718 1856461
TOTAL 10465510


The Net NPV after 4 years is 439901

(10465510 - 10025609 )






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 (10025609) -10025609 - -
Year 1 3468557 -6557052 3468557 0.8333 2890464
Year 2 3968378 -2588674 7436935 0.6944 2755818
Year 3 3942486 1353812 11379421 0.5787 2281531
Year 4 3246962 4600774 14626383 0.4823 1565857
TOTAL 9493671


The Net NPV after 4 years is -531938

At 20% discount rate the NPV is negative (9493671 - 10025609 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Housewares Oxo 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 Housewares Oxo has a NPV value higher than Zero then finance managers at Housewares Oxo 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 Housewares Oxo, then the stock price of the Housewares Oxo 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 Housewares Oxo 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 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 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.

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.




References & Further Readings

H. Kent Bowen, Marilyn E. Matis, Sylvie Ryckebusch (2018), "OXO International Harvard Business Review Case Study. Published by HBR Publications.