CircusTrix: The Ups and Downs of International Expansion 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 CircusTrix: The Ups and Downs of International Expansion case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. CircusTrix: The Ups and Downs of International Expansion case study is a Harvard Business School (HBR) case study written by Simon Greathead, Case Lawrence, Jonathan Richards. The CircusTrix: The Ups and Downs of International Expansion (referred as “Circustrix Trampoline” 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, Personnel policies, Social platforms.

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 CircusTrix: The Ups and Downs of International Expansion Case Study

CircusTrix Trampoline Parks (CircusTrix) was started in San Francisco, California, in 2011 after the founder first experienced an indoor trampoline park. Less than five years later, the business had grown to more than 28 facilities worldwide, grossing US$24.5 million in 2014 alone. The company had originally expanded internationally to maintain its first-mover status in the emerging extreme recreation industry, but was now facing a problem that could derail the company's international growth for years to come. A customer in the brand new CircusTrix park in Edinburgh, Scotland, had injured himself and blamed CircusTrix. As a result, city officials had shut down the facility, with another park scheduled to open in just over two weeks in Glasgow. The public relations issue was threatening to cost the founder not only his brand new operations in the United Kingdom, but likely also the additional upcoming locations in Germany, France, and Holland. Simon Greathead and Case Lawrence are affiliated with Brigham Young University.

Case Authors : Simon Greathead, Case Lawrence, Jonathan Richards

Topic : Leadership & Managing People

Related Areas : Growth strategy, Personnel policies, Social platforms

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Calculating Net Present Value (NPV) at 6% for CircusTrix: The Ups and Downs of International Expansion Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10003763)	-10003763	-	-
Year 1	3464963	-6538800	3464963	0.9434	3268833
Year 2	3954351	-2584449	7419314	0.89	3519358
Year 3	3945269	1360820	11364583	0.8396	3312524
Year 4	3235848	4596668	14600431	0.7921	2563095
TOTAL			14600431		12663810

The Net Present Value at 6% discount rate is 2660047

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

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. Circustrix Trampoline 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 Circustrix Trampoline 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 CircusTrix: The Ups and Downs of International Expansion

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 Circustrix Trampoline 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 Circustrix Trampoline 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	(10003763)	-10003763	-	-
Year 1	3464963	-6538800	3464963	0.8696	3013011
Year 2	3954351	-2584449	7419314	0.7561	2990057
Year 3	3945269	1360820	11364583	0.6575	2594078
Year 4	3235848	4596668	14600431	0.5718	1850107
TOTAL					10447254

The Net NPV after 4 years is 443491

(10447254 - 10003763 )

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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	(10003763)	-10003763	-	-
Year 1	3464963	-6538800	3464963	0.8333	2887469
Year 2	3954351	-2584449	7419314	0.6944	2746077
Year 3	3945269	1360820	11364583	0.5787	2283142
Year 4	3235848	4596668	14600431	0.4823	1560498
TOTAL					9477186

The Net NPV after 4 years is -526577

At 20% discount rate the NPV is negative (9477186 - 10003763 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Circustrix Trampoline 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 Circustrix Trampoline has a NPV value higher than Zero then finance managers at Circustrix Trampoline 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 Circustrix Trampoline, then the stock price of the Circustrix Trampoline 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 Circustrix Trampoline 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 –

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 can impact the cash flow of the project.

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

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.

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Negotiation Strategy of CircusTrix: The Ups and Downs of International Expansion

References & Further Readings

Simon Greathead, Case Lawrence, Jonathan Richards (2018), "CircusTrix: The Ups and Downs of International Expansion Harvard Business Review Case Study. Published by HBR Publications.