FIRMENICH: A PASSION FOR SMELL AND TASTE 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 FIRMENICH: A PASSION FOR SMELL AND TASTE case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. FIRMENICH: A PASSION FOR SMELL AND TASTE case study is a Harvard Business School (HBR) case study written by Benoit Leleux, Anne Catrin Glemser. The FIRMENICH: A PASSION FOR SMELL AND TASTE (referred as “Firmenich Family” 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, Innovation, Leadership, Technology.

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 FIRMENICH: A PASSION FOR SMELL AND TASTE Case Study

GENEVA, SWITZERLAND. At the end-of-year company presentation in December 2010; Patrick Firmenich (fourth generation); CEO of Firmenich International; was pleased to review another successful year. The 115-year-old; Geneva-based flavor and fragrances company had posted record sales; regained its growth leadership position after the worst recession in recent history and received unique industry accolades by winning two of the most prestigious perfumery awards. These confirmed Firmenich's exceptional creativity and sustainable commercial success. It was also a moment of reflection for Marie-Christine Jaeger-Firmenich (third generation); who was going into her ninth year as the "Firmenich Family Steward." When she took over the role; she had expected to step into a well-oiled family governance machine. But things did not quite go as planned. Family members rapidly came to her with multiple requests and new ideas on how to change the rules and decision-making processes in the family's governance system. Her main goal was to preserve the family unity over time while modernizing and updating its governance to face up to the new industrial challenges the family business would encounter in the future. By the summer of 2011; another threat was looming. With the sovereign debt crisis; the Swiss franc took on a renewed status as a refuge currency and skyrocketed in value against the dollar and the euro. While the group was operationally very global; it still had a strong manufacturing base in Switzerland and a strong Swiss franc exposure. How would this affect its future competitiveness? What could be done to control the future impact of foreign exchange fluctuations? Learning objectives: Managing growth; family business governance; technological leadership; competitive strategies.

Case Authors : Benoit Leleux, Anne Catrin Glemser

Topic : Leadership & Managing People

Related Areas : Innovation, Leadership, Technology

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Calculating Net Present Value (NPV) at 6% for FIRMENICH: A PASSION FOR SMELL AND TASTE Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018525)	-10018525	-	-
Year 1	3455226	-6563299	3455226	0.9434	3259647
Year 2	3956779	-2606520	7412005	0.89	3521519
Year 3	3949465	1342945	11361470	0.8396	3316047
Year 4	3249596	4592541	14611066	0.7921	2573984
TOTAL			14611066		12671198

The Net Present Value at 6% discount rate is 2652673

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

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. Firmenich Family 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 Firmenich Family 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 FIRMENICH: A PASSION FOR SMELL AND TASTE

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 Firmenich Family 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 Firmenich Family 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	(10018525)	-10018525	-	-
Year 1	3455226	-6563299	3455226	0.8696	3004544
Year 2	3956779	-2606520	7412005	0.7561	2991893
Year 3	3949465	1342945	11361470	0.6575	2596837
Year 4	3249596	4592541	14611066	0.5718	1857967
TOTAL					10451242

The Net NPV after 4 years is 432717

(10451242 - 10018525 )

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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	(10018525)	-10018525	-	-
Year 1	3455226	-6563299	3455226	0.8333	2879355
Year 2	3956779	-2606520	7412005	0.6944	2747763
Year 3	3949465	1342945	11361470	0.5787	2285570
Year 4	3249596	4592541	14611066	0.4823	1567128
TOTAL					9479816

The Net NPV after 4 years is -538709

At 20% discount rate the NPV is negative (9479816 - 10018525 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Firmenich Family 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 Firmenich Family has a NPV value higher than Zero then finance managers at Firmenich Family 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 Firmenich Family, then the stock price of the Firmenich Family 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 Firmenich Family 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 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.

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

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 FIRMENICH: A PASSION FOR SMELL AND TASTE

References & Further Readings

Benoit Leleux, Anne Catrin Glemser (2018), "FIRMENICH: A PASSION FOR SMELL AND TASTE Harvard Business Review Case Study. Published by HBR Publications.