Devonian Coast Wineries: Overcoming Provincial Barriers 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 Devonian Coast Wineries: Overcoming Provincial Barriers case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Devonian Coast Wineries: Overcoming Provincial Barriers case study is a Harvard Business School (HBR) case study written by W. Glenn Rowe, Paul Boothe, Ken Mark. The Devonian Coast Wineries: Overcoming Provincial Barriers (referred as “Wineries Provincial” 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, Regulation, Strategy.

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 Devonian Coast Wineries: Overcoming Provincial Barriers Case Study

By late 2015, the chief executive officer of Devonian Coast Wineries in the Canadian province of Nova Scotia had invested in the business and had broadened the distribution of the wines he produced. His chief concern was growing sales beyond Nova Scotia's provincial borders. Selling wines in other provinces was difficult because it required approaching the various provincial liquor control boards. He had three options: continue to engage with each provincial liquor board's buyers, lobby for greater retail access, or pursue the removal of provincial barriers to wine trade within the Atlantic provinces. If all interprovincial barriers were removed, he would need to compete with other provinces' larger wine producers, and they would likely gain market share at the expense of local wineries. What was the best strategy to expand Devonian Coast Wineries' distribution beyond Nova Scotia?

Case Authors : W. Glenn Rowe, Paul Boothe, Ken Mark

Topic : Leadership & Managing People

Related Areas : Regulation, Strategy

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Calculating Net Present Value (NPV) at 6% for Devonian Coast Wineries: Overcoming Provincial Barriers Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10009341)	-10009341	-	-
Year 1	3447588	-6561753	3447588	0.9434	3252442
Year 2	3978421	-2583332	7426009	0.89	3540781
Year 3	3974889	1391557	11400898	0.8396	3337393
Year 4	3251404	4642961	14652302	0.7921	2575417
TOTAL			14652302		12706032

The Net Present Value at 6% discount rate is 2696691

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. Net Present Value
3. Profitability Index
4. Payback Period

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. Wineries Provincial 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 Wineries Provincial 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 Devonian Coast Wineries: Overcoming Provincial Barriers

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 Wineries Provincial 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 Wineries Provincial 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	(10009341)	-10009341	-	-
Year 1	3447588	-6561753	3447588	0.8696	2997903
Year 2	3978421	-2583332	7426009	0.7561	3008258
Year 3	3974889	1391557	11400898	0.6575	2613554
Year 4	3251404	4642961	14652302	0.5718	1859001
TOTAL					10478715

The Net NPV after 4 years is 469374

(10478715 - 10009341 )

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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	(10009341)	-10009341	-	-
Year 1	3447588	-6561753	3447588	0.8333	2872990
Year 2	3978421	-2583332	7426009	0.6944	2762792
Year 3	3974889	1391557	11400898	0.5787	2300283
Year 4	3251404	4642961	14652302	0.4823	1568000
TOTAL					9504065

The Net NPV after 4 years is -505276

At 20% discount rate the NPV is negative (9504065 - 10009341 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Wineries Provincial 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 Wineries Provincial has a NPV value higher than Zero then finance managers at Wineries Provincial 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 Wineries Provincial, then the stock price of the Wineries Provincial 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 Wineries Provincial 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 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.

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

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 Devonian Coast Wineries: Overcoming Provincial Barriers

References & Further Readings

W. Glenn Rowe, Paul Boothe, Ken Mark (2018), "Devonian Coast Wineries: Overcoming Provincial Barriers Harvard Business Review Case Study. Published by HBR Publications.