NOIR/ILLUMINATI II (A): DEFINING SOCIALLY RESPONSIBLE AFFORDABLE LUXURY CLOTHING 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 NOIR/ILLUMINATI II (A): DEFINING SOCIALLY RESPONSIBLE AFFORDABLE LUXURY CLOTHING case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. NOIR/ILLUMINATI II (A): DEFINING SOCIALLY RESPONSIBLE AFFORDABLE LUXURY CLOTHING case study is a Harvard Business School (HBR) case study written by Benoit Leleux, Barbara Scheel. The NOIR/ILLUMINATI II (A): DEFINING SOCIALLY RESPONSIBLE AFFORDABLE LUXURY CLOTHING (referred as “Noir Fashion” 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, Social responsibility.

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 NOIR/ILLUMINATI II (A): DEFINING SOCIALLY RESPONSIBLE AFFORDABLE LUXURY CLOTHING Case Study

Peter looked out of his window. His window. He liked the sound of that. It had taken him 15 years of discipline and hard work to reach this point. And 2007 was going to be the year of Noir/Illuminati II. So far, after nine months, it looked very promising. Peter Ingwersen founded the companies in February 2005. The two entities were like Siamese twins; Noir designed and produced luxury clothing for women, while Illuminati II was set up to produce high quality cotton fabrics both for Noir and other leading fashion brands. Together, they provided the basis for a totally new concept in fashion. Over the years, Peter had attended many fashion shows all over world and had become both aware and very concerned by the total lack of "social substance" of many of the major fashion companies. Was fashion just the ultimate personalization of some of the worst aspects of human behavior? Was it all about egocentrism and showing off? Could something be done to bring back meaning and substance to the world of fashion? Corporate Social Responsibility (CSR) was making its way into most other industries: why could it not infiltrate fashion? Was there any way to improve the "feel good" factor of beautiful clothes with a clear social responsibility message? Could egocentrism rhyme with eco-friendliness? Conceptually it was very clear: Noir/Illuminati II would define socially responsible affordable luxury clothing. Putting the concept into operation was the real challenge. Building a brand on social awareness, or the guilt of conspicuous consumption, could clearly be a two-edged sword. Would customers buy the story? Even more pressing, would investors follow him in this venture? Learning objectives: Developing a brand, building CSR into an offering, fair-trade concepts, certified organic productions, managing growth in the fashion business, corporate communication, financing fast growth, product positioning.

Case Authors : Benoit Leleux, Barbara Scheel

Topic : Leadership & Managing People

Related Areas : Social responsibility

---

Calculating Net Present Value (NPV) at 6% for NOIR/ILLUMINATI II (A): DEFINING SOCIALLY RESPONSIBLE AFFORDABLE LUXURY CLOTHING Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016689)	-10016689	-	-
Year 1	3449510	-6567179	3449510	0.9434	3254255
Year 2	3981895	-2585284	7431405	0.89	3543872
Year 3	3952657	1367373	11384062	0.8396	3318727
Year 4	3238769	4606142	14622831	0.7921	2565408
TOTAL			14622831		12682263

The Net Present Value at 6% discount rate is 2665574

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. 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. Timing of the expected cash flows – stockholders of Noir Fashion 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. Noir Fashion 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 NOIR/ILLUMINATI II (A): DEFINING SOCIALLY RESPONSIBLE AFFORDABLE LUXURY CLOTHING

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 Noir Fashion 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 Noir Fashion 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	(10016689)	-10016689	-	-
Year 1	3449510	-6567179	3449510	0.8696	2999574
Year 2	3981895	-2585284	7431405	0.7561	3010885
Year 3	3952657	1367373	11384062	0.6575	2598936
Year 4	3238769	4606142	14622831	0.5718	1851777
TOTAL					10461171

The Net NPV after 4 years is 444482

(10461171 - 10016689 )

---

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	(10016689)	-10016689	-	-
Year 1	3449510	-6567179	3449510	0.8333	2874592
Year 2	3981895	-2585284	7431405	0.6944	2765205
Year 3	3952657	1367373	11384062	0.5787	2287417
Year 4	3238769	4606142	14622831	0.4823	1561906
TOTAL					9489120

The Net NPV after 4 years is -527569

At 20% discount rate the NPV is negative (9489120 - 10016689 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Noir Fashion 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 Noir Fashion has a NPV value higher than Zero then finance managers at Noir Fashion 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 Noir Fashion, then the stock price of the Noir Fashion 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 Noir Fashion 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.

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 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.

---

Negotiation Strategy of NOIR/ILLUMINATI II (A): DEFINING SOCIALLY RESPONSIBLE AFFORDABLE LUXURY CLOTHING

References & Further Readings

Benoit Leleux, Barbara Scheel (2018), "NOIR/ILLUMINATI II (A): DEFINING SOCIALLY RESPONSIBLE AFFORDABLE LUXURY CLOTHING Harvard Business Review Case Study. Published by HBR Publications.