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Starbucks Corporation: Financial Analysis of a Business Strategy 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 Starbucks Corporation: Financial Analysis of a Business Strategy case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Starbucks Corporation: Financial Analysis of a Business Strategy case study is a Harvard Business School (HBR) case study written by Kathleen Hevert. The Starbucks Corporation: Financial Analysis of a Business Strategy (referred as “Starbucks Financial” 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, Financial management.

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 Starbucks Corporation: Financial Analysis of a Business Strategy Case Study


This note introduces calculation and interpretation of basic financial analysis, including common size income statements and financial ratios. It emphasizes linkages between financial results and operating strategy. It uses financial results for Starbucks Corporation for fiscal 2010 through 2012 to provide context for financial analysis interpretation. Starbucks' global presence and widely familiar business model make it a particularly helpful vehicle for illustrating interpretation of financial analysis. In addition to profitability ratios, asset management ratios, and financial leverage ratios, DuPont analysis of return on equity (ROE) is introduced to illustrate how profitability, asset utilization, and financial leverage come together to measure ability to generate return to shareholders. This note does not draw definitive conclusions about whether Starbucks is effectively managed, but it illustrates how Starbucks' operating strategy is reflected in its financial results. It demonstrates that financial results tell an intuitive story about a firm's business model and operating strategy. This note assumes a working knowledge of income statements and balance sheets. Its intended audience is non-financial managers in an executive program wishing to understand how their operating decisions affect corporate-level financial performance. It also is useful for MBA students in a core finance or accounting course.


Case Authors : Kathleen Hevert

Topic : Leadership & Managing People

Related Areas : Financial management




Calculating Net Present Value (NPV) at 6% for Starbucks Corporation: Financial Analysis of a Business Strategy Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10024853) -10024853 - -
Year 1 3451725 -6573128 3451725 0.9434 3256344
Year 2 3963335 -2609793 7415060 0.89 3527354
Year 3 3945327 1335534 11360387 0.8396 3312573
Year 4 3235329 4570863 14595716 0.7921 2562684
TOTAL 14595716 12658955




The Net Present Value at 6% discount rate is 2634102

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. Net Present Value
2. Payback Period
3. Profitability Index
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 Starbucks Financial 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. Starbucks Financial 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 Starbucks Corporation: Financial Analysis of a Business Strategy

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 Starbucks Financial 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 Starbucks Financial 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 (10024853) -10024853 - -
Year 1 3451725 -6573128 3451725 0.8696 3001500
Year 2 3963335 -2609793 7415060 0.7561 2996851
Year 3 3945327 1335534 11360387 0.6575 2594117
Year 4 3235329 4570863 14595716 0.5718 1849810
TOTAL 10442277


The Net NPV after 4 years is 417424

(10442277 - 10024853 )








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 (10024853) -10024853 - -
Year 1 3451725 -6573128 3451725 0.8333 2876438
Year 2 3963335 -2609793 7415060 0.6944 2752316
Year 3 3945327 1335534 11360387 0.5787 2283175
Year 4 3235329 4570863 14595716 0.4823 1560247
TOTAL 9472176


The Net NPV after 4 years is -552677

At 20% discount rate the NPV is negative (9472176 - 10024853 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Starbucks Financial 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 Starbucks Financial has a NPV value higher than Zero then finance managers at Starbucks Financial 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 Starbucks Financial, then the stock price of the Starbucks Financial 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 Starbucks Financial 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.

What can impact the cash flow of the project.

Understanding of risks involved in 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.






Negotiation Strategy of Starbucks Corporation: Financial Analysis of a Business Strategy

References & Further Readings

Kathleen Hevert (2018), "Starbucks Corporation: Financial Analysis of a Business Strategy Harvard Business Review Case Study. Published by HBR Publications.


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