Khao Yai Winery: An Economic Perspective 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 Khao Yai Winery: An Economic Perspective case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Khao Yai Winery: An Economic Perspective case study is a Harvard Business School (HBR) case study written by Jordan A. French. The Khao Yai Winery: An Economic Perspective (referred as “Elasticities Khao” 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, .

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 Khao Yai Winery: An Economic Perspective Case Study

In 2015, the marketing and business developer at Khao Yai Winery in Thailand wondered whether a new excise tax, which the government implemented in 2012, had led to a decrease in sales despite an overall increase in wine consumption in Thailand. Before deciding whether he should lobby the government to lower the excise tax, he tasked three interns to examine how the government's taxes on imported and domestic wines affected the winery. The interns also needed to determine how the government policies would be affected by various elasticities-income elasticities, own-price elasticities, and cross-price elasticities. Jordan French is affiliated with Stamford International University.

Case Authors : Jordan A. French

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Khao Yai Winery: An Economic Perspective Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10006370)	-10006370	-	-
Year 1	3468754	-6537616	3468754	0.9434	3272409
Year 2	3959693	-2577923	7428447	0.89	3524113
Year 3	3968665	1390742	11397112	0.8396	3332168
Year 4	3224498	4615240	14621610	0.7921	2554104
TOTAL			14621610		12682794

The Net Present Value at 6% discount rate is 2676424

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. Profitability Index
3. Payback Period
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. Elasticities Khao 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 Elasticities Khao 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 Khao Yai Winery: An Economic Perspective

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 Elasticities Khao 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 Elasticities Khao 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	(10006370)	-10006370	-	-
Year 1	3468754	-6537616	3468754	0.8696	3016308
Year 2	3959693	-2577923	7428447	0.7561	2994097
Year 3	3968665	1390742	11397112	0.6575	2609462
Year 4	3224498	4615240	14621610	0.5718	1843617
TOTAL					10463483

The Net NPV after 4 years is 457113

(10463483 - 10006370 )

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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	(10006370)	-10006370	-	-
Year 1	3468754	-6537616	3468754	0.8333	2890628
Year 2	3959693	-2577923	7428447	0.6944	2749787
Year 3	3968665	1390742	11397112	0.5787	2296681
Year 4	3224498	4615240	14621610	0.4823	1555024
TOTAL					9492120

The Net NPV after 4 years is -514250

At 20% discount rate the NPV is negative (9492120 - 10006370 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Elasticities Khao 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 Elasticities Khao has a NPV value higher than Zero then finance managers at Elasticities Khao 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 Elasticities Khao, then the stock price of the Elasticities Khao 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 Elasticities Khao 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 Khao Yai Winery: An Economic Perspective

References & Further Readings

Jordan A. French (2018), "Khao Yai Winery: An Economic Perspective Harvard Business Review Case Study. Published by HBR Publications.