Passion for Pets: An Interview with Philip L. Francis, Chairperson and CEO of PETsMART, Inc. 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 Passion for Pets: An Interview with Philip L. Francis, Chairperson and CEO of PETsMART, Inc. case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Passion for Pets: An Interview with Philip L. Francis, Chairperson and CEO of PETsMART, Inc. case study is a Harvard Business School (HBR) case study written by Catherine M. Dalton. The Passion for Pets: An Interview with Philip L. Francis, Chairperson and CEO of PETsMART, Inc. (referred as “Petsmart Francis” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Growth strategy, Hiring, Leadership.

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 Passion for Pets: An Interview with Philip L. Francis, Chairperson and CEO of PETsMART, Inc. Case Study

Phil Francis loves Bit-O-Honey. No, not the chewy honey-flavored taffy with bits of almond, but his adorable mixed breed dog, Bit O'Honey. As a pet parent, Francis is a perfect exemplar of the typical PETsMART executive. Francis joined PETsMART in 1989 as a director. After 10 years of distinguished service as a board member, he was named CEO in March 1998 and chairman of the board in October 1999. Prior to being named CEO of PETsMART, Francis enjoyed a distinguished career in retail, serving in a variety of management positions with Shaw's Supermarkets, Inc., a subsidiary of J. Sainsbury plc; Roundy's Inc.; Cardinal Health; and the Jewel Companies. PETsMART is the leading retail supplier of pet products and services in the United States. In addition to more than 700 retail outlets in the United States and Canada, the company operates a large catalog business and a leading Internet pet product Web site. Francis reveals his passion for the pet services and products business and his enthusiasm for PETsMART's positioning within the industry. He also shares his insights into the company's growth opportunities, especially within the area of pet services.

Case Authors : Catherine M. Dalton

Topic : Leadership & Managing People

Related Areas : Growth strategy, Hiring, Leadership

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Calculating Net Present Value (NPV) at 6% for Passion for Pets: An Interview with Philip L. Francis, Chairperson and CEO of PETsMART, Inc. Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10013525)	-10013525	-	-
Year 1	3457179	-6556346	3457179	0.9434	3261490
Year 2	3974113	-2582233	7431292	0.89	3536946
Year 3	3939118	1356885	11370410	0.8396	3307359
Year 4	3244584	4601469	14614994	0.7921	2570014
TOTAL			14614994		12675810

The Net Present Value at 6% discount rate is 2662285

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. Payback Period
2. Net Present Value
3. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Petsmart Francis 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 Petsmart Francis 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 Passion for Pets: An Interview with Philip L. Francis, Chairperson and CEO of PETsMART, Inc.

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 Leadership & Managing People 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 Petsmart Francis 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 Petsmart Francis 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	(10013525)	-10013525	-	-
Year 1	3457179	-6556346	3457179	0.8696	3006243
Year 2	3974113	-2582233	7431292	0.7561	3005000
Year 3	3939118	1356885	11370410	0.6575	2590034
Year 4	3244584	4601469	14614994	0.5718	1855101
TOTAL					10456378

The Net NPV after 4 years is 442853

(10456378 - 10013525 )

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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	(10013525)	-10013525	-	-
Year 1	3457179	-6556346	3457179	0.8333	2880983
Year 2	3974113	-2582233	7431292	0.6944	2759801
Year 3	3939118	1356885	11370410	0.5787	2279582
Year 4	3244584	4601469	14614994	0.4823	1564711
TOTAL					9485076

The Net NPV after 4 years is -528449

At 20% discount rate the NPV is negative (9485076 - 10013525 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Petsmart Francis 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 Petsmart Francis has a NPV value higher than Zero then finance managers at Petsmart Francis 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 Petsmart Francis, then the stock price of the Petsmart Francis 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 Petsmart Francis 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 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 will be a multi year spillover effect of various taxation regulations.

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 Passion for Pets: An Interview with Philip L. Francis, Chairperson and CEO of PETsMART, Inc.

References & Further Readings

Catherine M. Dalton (2018), "Passion for Pets: An Interview with Philip L. Francis, Chairperson and CEO of PETsMART, Inc. Harvard Business Review Case Study. Published by HBR Publications.