Supercompra: Sourcing from Small Andean Farmers 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 Supercompra: Sourcing from Small Andean Farmers case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Supercompra: Sourcing from Small Andean Farmers case study is a Harvard Business School (HBR) case study written by Josefina F. Bruni-Celli, Manuela Plaza. The Supercompra: Sourcing from Small Andean Farmers (referred as “Supercompra Farmers” 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, Supply chain.

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 Supercompra: Sourcing from Small Andean Farmers Case Study

Grupo Mazaplan, a Mexican giant, entered the Ecuadorian market by purchasing controlling interest in Supercompra, a large local retailing company. Juan Pedro Zapata, Supercompra's incoming CEO discarded a purchasing model whereby a central company office sourced all produce from national distributors who then made direct deliveries to points of sale, and substituted it with another featuring decentralized company units called "proximity platforms" located in various parts of the country, which bought produce directly from local farmers. The first platform was established in the Andean region, where farmers were smallholders. The case looks at the difficulties faced by companies when trying to develop commercial relations with low-income suppliers through market mechanisms, and elaborates on how Supercompra handled these relationships. It is chronologically situated in March 2006, the moment when Supercompra must decide how to proceed regarding its relationship with its low income suppliers: 1) allow relations with small Pallatanga growers to dwindle away, discontinuing further efforts and resources invested in organizing them, and dedicating efforts entirely to building relationships with local middlemen and larger commercial farmers; 2) continue to work on the relationship with small growers, but reframe it as a social or CSR initiative; or, 3) allocate more efforts and financial resources to building stable and solid business relationships with small producers, which would imply making a major investment, and dedicating additional time and effort organizing and fostering small farmers with the hope of achieving profitable commercial relations with them within a few years.

Case Authors : Josefina F. Bruni-Celli, Manuela Plaza

Topic : Leadership & Managing People

Related Areas : Supply chain

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Calculating Net Present Value (NPV) at 6% for Supercompra: Sourcing from Small Andean Farmers Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10021694)	-10021694	-	-
Year 1	3444911	-6576783	3444911	0.9434	3249916
Year 2	3970802	-2605981	7415713	0.89	3534000
Year 3	3937884	1331903	11353597	0.8396	3306323
Year 4	3228776	4560679	14582373	0.7921	2557493
TOTAL			14582373		12647732

The Net Present Value at 6% discount rate is 2626038

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. Profitability Index
2. Net Present Value
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Supercompra Farmers 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 Supercompra Farmers 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 Supercompra: Sourcing from Small Andean Farmers

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 Supercompra Farmers 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 Supercompra Farmers 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	(10021694)	-10021694	-	-
Year 1	3444911	-6576783	3444911	0.8696	2995575
Year 2	3970802	-2605981	7415713	0.7561	3002497
Year 3	3937884	1331903	11353597	0.6575	2589223
Year 4	3228776	4560679	14582373	0.5718	1846063
TOTAL					10433357

The Net NPV after 4 years is 411663

(10433357 - 10021694 )

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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	(10021694)	-10021694	-	-
Year 1	3444911	-6576783	3444911	0.8333	2870759
Year 2	3970802	-2605981	7415713	0.6944	2757501
Year 3	3937884	1331903	11353597	0.5787	2278868
Year 4	3228776	4560679	14582373	0.4823	1557087
TOTAL					9464216

The Net NPV after 4 years is -557478

At 20% discount rate the NPV is negative (9464216 - 10021694 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Supercompra Farmers 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 Supercompra Farmers has a NPV value higher than Zero then finance managers at Supercompra Farmers 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 Supercompra Farmers, then the stock price of the Supercompra Farmers 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 Supercompra Farmers 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.

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.

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

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 Supercompra: Sourcing from Small Andean Farmers

References & Further Readings

Josefina F. Bruni-Celli, Manuela Plaza (2018), "Supercompra: Sourcing from Small Andean Farmers Harvard Business Review Case Study. Published by HBR Publications.