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NPV: Chocolate Remedies: A Healthy Twist Net Present Value Case Analysis

Chocolate Remedies: A Healthy Twist 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 Chocolate Remedies: A Healthy Twist case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Chocolate Remedies: A Healthy Twist case study is a Harvard Business School (HBR) case study written by Dennis Ceru, Beth Goldstein. The Chocolate Remedies: A Healthy Twist (referred as “Chocolate A” 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 management, Marketing, Sales.

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 Chocolate Remedies: A Healthy Twist Case Study

Chocolate Remedies tells the story of an African American couple working together to build their own retail business specializing in sales of high-quality, hand-made, chocolate truffles. The case follows their path as they launch two coffee shops that fail after five years of slow growth and limited revenue, leaving them in debt. The couple returns to corporate positions and rebuilds their financial security. Next, they decide to invest their savings to develop a retail chocolate business. They establish a retail location but watch sales plummet after the first year, leading them to move to a new location and seek a business model that will bring them success. The case addresses the following topics. a?? The factors involved, personal as well as financial, in the decision to build rather than buy a business. a?? The relationship linking market research and analysis, to their choice of location, as it impacts the success of a retail business. a?? The importance of product lines, sales channels, and accurate financial monitoring in crafting a business model that produces revenues and profits.

Case Authors : Dennis Ceru, Beth Goldstein

Topic : Innovation & Entrepreneurship

Related Areas : Financial management, Marketing, Sales

Calculating Net Present Value (NPV) at 6% for Chocolate Remedies: A Healthy Twist Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10018155) -10018155 - -
Year 1 3452248 -6565907 3452248 0.9434 3256838
Year 2 3971077 -2594830 7423325 0.89 3534244
Year 3 3936956 1342126 11360281 0.8396 3305544
Year 4 3246875 4589001 14607156 0.7921 2571829
TOTAL 14607156 12668455

The Net Present Value at 6% discount rate is 2650300

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. 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 Chocolate A 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. Chocolate A 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 Chocolate Remedies: A Healthy Twist

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 Chocolate A 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 Chocolate A 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 %
Cash Flows
Year 0 (10018155) -10018155 - -
Year 1 3452248 -6565907 3452248 0.8696 3001955
Year 2 3971077 -2594830 7423325 0.7561 3002705
Year 3 3936956 1342126 11360281 0.6575 2588612
Year 4 3246875 4589001 14607156 0.5718 1856411
TOTAL 10449683

The Net NPV after 4 years is 431528

(10449683 - 10018155 )

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 %
Cash Flows
Year 0 (10018155) -10018155 - -
Year 1 3452248 -6565907 3452248 0.8333 2876873
Year 2 3971077 -2594830 7423325 0.6944 2757692
Year 3 3936956 1342126 11360281 0.5787 2278331
Year 4 3246875 4589001 14607156 0.4823 1565815
TOTAL 9478712

The Net NPV after 4 years is -539443

At 20% discount rate the NPV is negative (9478712 - 10018155 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Chocolate A 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 Chocolate A has a NPV value higher than Zero then finance managers at Chocolate A 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 Chocolate A, then the stock price of the Chocolate A 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 Chocolate A 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 can impact the cash flow of the project.

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 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.

References & Further Readings

Dennis Ceru, Beth Goldstein (2018), "Chocolate Remedies: A Healthy Twist Harvard Business Review Case Study. Published by HBR Publications.