Ferris Valley Foods Company: Corporate Social Responsibility and Reentry 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 Ferris Valley Foods Company: Corporate Social Responsibility and Reentry case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Ferris Valley Foods Company: Corporate Social Responsibility and Reentry case study is a Harvard Business School (HBR) case study written by Lisa Eshbach, Nancy M. Levenburg. The Ferris Valley Foods Company: Corporate Social Responsibility and Reentry (referred as “Offenders Ferris” 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, Hiring, Human resource management, Social enterprise, 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

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Case Description of Ferris Valley Foods Company: Corporate Social Responsibility and Reentry Case Study

Ned Larsen, the CEO of Ferris Valley Foods Company (FVF), located in westernMichigan, was focusing on the issue of hiring ex-felons. He planned to ask his management team to consider if (and how) FVF could use information obtained from the Michigan Department of Corrections (and the Michigan Prisoner Reentry Initiative) and West Michigan Therapy, Inc. to benefit people like Lori Mitten, a middle-aged ex-offender who recently earned a Bachelor of Business Administration degree and was seeking employment. In a deeper sense, Ferris Valley Foods Company also needed to consider the meaning of corporate social responsibility, with respect to the human, financial, and time-related resources that would be required in order to reach out to ex-offenders. One option might be to adopt a hands-off approach and either do nothing at all or simply make a financial donation to a non-profit organization that provides support for ex-offenders; another could be to become actively involved in partnering with the aforementioned entities. Finally, it could begin to hire ex-offenders. Additional (ethical) complications arise because the CEO's nephew is one of the ex-offenders portrayed in the case.

Case Authors : Lisa Eshbach, Nancy M. Levenburg

Topic : Leadership & Managing People

Related Areas : Hiring, Human resource management, Social enterprise, Social responsibility

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Calculating Net Present Value (NPV) at 6% for Ferris Valley Foods Company: Corporate Social Responsibility and Reentry Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10028121)	-10028121	-	-
Year 1	3468938	-6559183	3468938	0.9434	3272583
Year 2	3962811	-2596372	7431749	0.89	3526888
Year 3	3937187	1340815	11368936	0.8396	3305738
Year 4	3230960	4571775	14599896	0.7921	2559223
TOTAL			14599896		12664432

The Net Present Value at 6% discount rate is 2636311

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. Timing of the expected cash flows – stockholders of Offenders Ferris 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. Offenders Ferris shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

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Formula and Steps to Calculate Net Present Value (NPV) of Ferris Valley Foods Company: Corporate Social Responsibility and Reentry

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 Offenders Ferris 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 Offenders Ferris 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	(10028121)	-10028121	-	-
Year 1	3468938	-6559183	3468938	0.8696	3016468
Year 2	3962811	-2596372	7431749	0.7561	2996454
Year 3	3937187	1340815	11368936	0.6575	2588764
Year 4	3230960	4571775	14599896	0.5718	1847312
TOTAL					10448998

The Net NPV after 4 years is 420877

(10448998 - 10028121 )

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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	(10028121)	-10028121	-	-
Year 1	3468938	-6559183	3468938	0.8333	2890782
Year 2	3962811	-2596372	7431749	0.6944	2751952
Year 3	3937187	1340815	11368936	0.5787	2278465
Year 4	3230960	4571775	14599896	0.4823	1558140
TOTAL					9479339

The Net NPV after 4 years is -548782

At 20% discount rate the NPV is negative (9479339 - 10028121 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Offenders Ferris 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 Offenders Ferris has a NPV value higher than Zero then finance managers at Offenders Ferris 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 Offenders Ferris, then the stock price of the Offenders Ferris 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 Offenders Ferris 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 will be a multi year spillover effect of various taxation regulations.

What can impact the cash flow of the project.

Understanding of risks involved in the project.

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 Ferris Valley Foods Company: Corporate Social Responsibility and Reentry

References & Further Readings

Lisa Eshbach, Nancy M. Levenburg (2018), "Ferris Valley Foods Company: Corporate Social Responsibility and Reentry Harvard Business Review Case Study. Published by HBR Publications.