Ina Food Industry (2): Marketing Strategies in a Deflationary Environment 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 Ina Food Industry (2): Marketing Strategies in a Deflationary Environment case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Ina Food Industry (2): Marketing Strategies in a Deflationary Environment case study is a Harvard Business School (HBR) case study written by Mitsuru Misawa. The Ina Food Industry (2): Marketing Strategies in a Deflationary Environment (referred as “Ina Tsukakoshi” 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, Marketing.

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 Ina Food Industry (2): Marketing Strategies in a Deflationary Environment Case Study

Ina Food Industry Co. Ltd. ("Ina Food") is situated in the city of Ina, Nagano Prefecture, and surrounded by the soaring mountains of the Japanese Alps. Hiroshi Tsukakoshi, Ina Food's 75-year-old chairman, has led the company through an incredible 55 years of continuous revenue and profit growth. The company is a leading manufacturer of powdered agar, a traditional gelatin product derived from seaweed. In the summer of 2012, Tsukakoshi is looking through the windows of his office in Ina City. He is thinking about how he aims for his company to be a corporation that is conscious of the global environment. He feels he has done a good job so far. The business has prospered and does not present any urgent problems. However, he also feels that he should not simply sit back and savor his success. He is facing his retirement and has concerns about the long-term growth of the company. He is thinking it might be the right time to introduce some new marketing strategies for the company. There is also another reason for concern: Japan's deflationary environment, persistent for 20 years now. He is interested in increasing sales volume and profit by raising prices when most other companies are lowering theirs under deflation. In this environment, even keeping prices constant means a relative increase of price. Tsukakoshi believes that, in essence, as long as a company is confident in the competitiveness of its products, there are always methods to raise prices and increase profits. The key is raising the prices of merchandise and services in a way that the customers can accept. Raising prices in a difficult economic climate is a risky decision. Nevertheless, the company is successful in raising the price under deflation. While the Japanese economy faces serious difficulties, the company has obtained successful results thanks to marketing, producing, financing, and allocating resources.

Case Authors : Mitsuru Misawa

Topic : Leadership & Managing People

Related Areas : Marketing

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Calculating Net Present Value (NPV) at 6% for Ina Food Industry (2): Marketing Strategies in a Deflationary Environment Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10004487)	-10004487	-	-
Year 1	3456400	-6548087	3456400	0.9434	3260755
Year 2	3975838	-2572249	7432238	0.89	3538482
Year 3	3972099	1399850	11404337	0.8396	3335051
Year 4	3224180	4624030	14628517	0.7921	2553853
TOTAL			14628517		12688140

The Net Present Value at 6% discount rate is 2683653

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. Profitability Index
3. Payback Period
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. Ina Tsukakoshi 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 Ina Tsukakoshi 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 Ina Food Industry (2): Marketing Strategies in a Deflationary Environment

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 Ina Tsukakoshi 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 Ina Tsukakoshi 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	(10004487)	-10004487	-	-
Year 1	3456400	-6548087	3456400	0.8696	3005565
Year 2	3975838	-2572249	7432238	0.7561	3006305
Year 3	3972099	1399850	11404337	0.6575	2611720
Year 4	3224180	4624030	14628517	0.5718	1843435
TOTAL					10467025

The Net NPV after 4 years is 462538

(10467025 - 10004487 )

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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	(10004487)	-10004487	-	-
Year 1	3456400	-6548087	3456400	0.8333	2880333
Year 2	3975838	-2572249	7432238	0.6944	2760999
Year 3	3972099	1399850	11404337	0.5787	2298668
Year 4	3224180	4624030	14628517	0.4823	1554871
TOTAL					9494871

The Net NPV after 4 years is -509616

At 20% discount rate the NPV is negative (9494871 - 10004487 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ina Tsukakoshi 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 Ina Tsukakoshi has a NPV value higher than Zero then finance managers at Ina Tsukakoshi 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 Ina Tsukakoshi, then the stock price of the Ina Tsukakoshi 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 Ina Tsukakoshi 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.

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.

Understanding of risks involved in 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 Ina Food Industry (2): Marketing Strategies in a Deflationary Environment

References & Further Readings

Mitsuru Misawa (2018), "Ina Food Industry (2): Marketing Strategies in a Deflationary Environment Harvard Business Review Case Study. Published by HBR Publications.