SPANISH VINES: COLOMBIAN MARKET ENTRY 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 SPANISH VINES: COLOMBIAN MARKET ENTRY case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. SPANISH VINES: COLOMBIAN MARKET ENTRY case study is a Harvard Business School (HBR) case study written by Martin Roth, Dominique Turpin. The SPANISH VINES: COLOMBIAN MARKET ENTRY (referred as “Sv Hackler” 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, Entrepreneurship.

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 SPANISH VINES: COLOMBIAN MARKET ENTRY Case Study

In 2006, young entrepreneur Josh Hackler started Spanish Vines (SV) to import Spanish wine into the United States. In 2009 SV recorded its first sales, and it has been growing ever since.By the end of 2012, it had secured distribution in eight US states and the District of Columbia (the nation's capital, Washington, DC), with many more states in various stages of development. The company's home market strategy was successful and growing. In 2012, a trade agreement between the European Union (EU) and Colombia (as well as Peru) was announced that would eliminate the value added tax on European wines imported into Colombia. Hackler saw this as an opportunity to be an early mover into Colombia. One of the key strategies SV would have to develop and implement was an effective launch plan. Specifically, how should the company generate awareness of, interest in, willingness to try and brand loyalty for SV products? And what brand, or set of brands, should SV launch in the Colombian market? While there are also important distribution and pricing issues that SV would have to tackle, this case focuses on the product, marketing communication and branding issues necessary to begin "pulling" customers toward the brand(s). The case presents background information on the company, global and Spanish wine industries, and the Colombian economy and wine market. The case concludes with the following questions for students to ponder: Is the Colombian opportunity the right one to begin expanding SV's international footprint? If so, should Hackler launch with house brands, partner brands or both? And what message and media could he use to tell the SV story and make his first venture into Latin America a success? Learning objectives: (1) Foreign market attractiveness, in particular the pursuit of opportunistic growth strategies; (2) Challenges small, entrepreneurial businesses face when building brands, generating consumer awareness and interest and gaining distribution coverage; (3) Strengths and limitations of export-import business models for new market entry; (4) Market comparisons, specifically as they pertain to customer segments, target markets and product positioning strategies; (5) Message and media communications challenges in launching a new brand in a new market on a limited budget.

Case Authors : Martin Roth, Dominique Turpin

Topic : Leadership & Managing People

Related Areas : Entrepreneurship

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Calculating Net Present Value (NPV) at 6% for SPANISH VINES: COLOMBIAN MARKET ENTRY Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10006415)	-10006415	-	-
Year 1	3469774	-6536641	3469774	0.9434	3273372
Year 2	3971326	-2565315	7441100	0.89	3534466
Year 3	3960148	1394833	11401248	0.8396	3325017
Year 4	3226844	4621677	14628092	0.7921	2555963
TOTAL			14628092		12688817

The Net Present Value at 6% discount rate is 2682402

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. Net Present Value
2. Internal Rate of Return
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Sv Hackler 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 Sv Hackler 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 SPANISH VINES: COLOMBIAN MARKET ENTRY

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 Sv Hackler 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 Sv Hackler 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	(10006415)	-10006415	-	-
Year 1	3469774	-6536641	3469774	0.8696	3017195
Year 2	3971326	-2565315	7441100	0.7561	3002893
Year 3	3960148	1394833	11401248	0.6575	2603862
Year 4	3226844	4621677	14628092	0.5718	1844959
TOTAL					10468908

The Net NPV after 4 years is 462493

(10468908 - 10006415 )

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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	(10006415)	-10006415	-	-
Year 1	3469774	-6536641	3469774	0.8333	2891478
Year 2	3971326	-2565315	7441100	0.6944	2757865
Year 3	3960148	1394833	11401248	0.5787	2291752
Year 4	3226844	4621677	14628092	0.4823	1556155
TOTAL					9497251

The Net NPV after 4 years is -509164

At 20% discount rate the NPV is negative (9497251 - 10006415 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Sv Hackler 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 Sv Hackler has a NPV value higher than Zero then finance managers at Sv Hackler 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 Sv Hackler, then the stock price of the Sv Hackler 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 Sv Hackler 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.

Understanding of risks involved in the project.

What can impact the cash flow of 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 SPANISH VINES: COLOMBIAN MARKET ENTRY

References & Further Readings

Martin Roth, Dominique Turpin (2018), "SPANISH VINES: COLOMBIAN MARKET ENTRY Harvard Business Review Case Study. Published by HBR Publications.