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Marimekko 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 Marimekko case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Marimekko case study is a Harvard Business School (HBR) case study written by Alison Konrad, Jordan Mitchell. The Marimekko (referred as “Paakkanen Marimekko” 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, Organizational structure, Sales, Succession planning.

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 Marimekko Case Study


Kirsti Paakkanen has achieved a celebrity status in Finland for her enigmatic leadership of the Finnish design company Marimekko. Purchasing the company in a state of near bankruptcy in 1991, Paakkanen took several actions to restore profitability and realize growth. As of 2006, the company has sales of 64 million euros (of which 80% are from Finland) and net profits of 8.4 million euros. Over the last few years, Paakkanen and her team have focused on growing international sales. Recently, the company has opened concept shops owned by foreign partners in Japan, the United Arab Emirates, Iceland, Sweden, and the United States. In light of the international expansion, Paakkanen is wondering if any changes to Marimekko's personnel policies and/or organization structure are necessary.


Case Authors : Alison Konrad, Jordan Mitchell

Topic : Leadership & Managing People

Related Areas : Organizational structure, Sales, Succession planning




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


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10011951) -10011951 - -
Year 1 3470009 -6541942 3470009 0.9434 3273593
Year 2 3955881 -2586061 7425890 0.89 3520720
Year 3 3970437 1384376 11396327 0.8396 3333655
Year 4 3222257 4606633 14618584 0.7921 2552329
TOTAL 14618584 12680298


The Net Present Value at 6% discount rate is 2668347

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. Payback Period
3. Net Present Value
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 Paakkanen Marimekko 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. Paakkanen Marimekko 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 Marimekko

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 Paakkanen Marimekko 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 Paakkanen Marimekko 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 (10011951) -10011951 - -
Year 1 3470009 -6541942 3470009 0.8696 3017399
Year 2 3955881 -2586061 7425890 0.7561 2991214
Year 3 3970437 1384376 11396327 0.6575 2610627
Year 4 3222257 4606633 14618584 0.5718 1842336
TOTAL 10461576


The Net NPV after 4 years is 449625

(10461576 - 10011951 )






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 (10011951) -10011951 - -
Year 1 3470009 -6541942 3470009 0.8333 2891674
Year 2 3955881 -2586061 7425890 0.6944 2747140
Year 3 3970437 1384376 11396327 0.5787 2297707
Year 4 3222257 4606633 14618584 0.4823 1553943
TOTAL 9490464


The Net NPV after 4 years is -521487

At 20% discount rate the NPV is negative (9490464 - 10011951 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Paakkanen Marimekko 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 Paakkanen Marimekko has a NPV value higher than Zero then finance managers at Paakkanen Marimekko 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 Paakkanen Marimekko, then the stock price of the Paakkanen Marimekko 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 Paakkanen Marimekko 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.

Understanding of risks involved in 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.

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

Alison Konrad, Jordan Mitchell (2018), "Marimekko Harvard Business Review Case Study. Published by HBR Publications.