Tough Decisions at Marks and Spencer 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 Tough Decisions at Marks and Spencer case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Tough Decisions at Marks and Spencer case study is a Harvard Business School (HBR) case study written by Robert G. Eccles, George Serafeim, Kyle Armbrester. The Tough Decisions at Marks and Spencer (referred as “Plan Spencer” 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, Communication, Competitive strategy, Decision making, Motivating people, Social responsibility, Supply chain, Sustainability.

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 Tough Decisions at Marks and Spencer Case Study

In 2007, under the leadership of CEO Stuart Rose, the iconic British retailer Marks and Spencer, with great fanfare, announced its "Plan A" initiative. Based on the five essential pillars of climate change, waste, sustainable materials, fair partnership, and health, the plan sought to transform the company's practices. By 2012, the program's aim was to ensure that M&S was carbon neutral and sent no waste to landfill. It also aimed to help its customers and employees achieve a healthier lifestyle, and to improve the lives of all involved in the company's supply chain with fair wages, as well as improved working hours and conditions. Called Plan A "because there is no Plan B," the company identified 180 projects to improve the sustainability of its operations and business practices in anticipation of the need for a very different business model in the future. Key aspects of Plan A included more sustainable sourcing and influencing the business practices of the company's supply chain; communication to employees, customers and investors; and employee engagement. The case concludes with the tradeoffs involved in the decision of whether or not to install refrigerator doors in the grocery section of its stores. While the energy savings and reduced carbon emissions are relatively clear and easy to measure, the impact on customers and revenues is harder to assess.

Case Authors : Robert G. Eccles, George Serafeim, Kyle Armbrester

Topic : Leadership & Managing People

Related Areas : Communication, Competitive strategy, Decision making, Motivating people, Social responsibility, Supply chain, Sustainability

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Calculating Net Present Value (NPV) at 6% for Tough Decisions at Marks and Spencer Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10018818)	-10018818	-	-
Year 1	3445158	-6573660	3445158	0.9434	3250149
Year 2	3969734	-2603926	7414892	0.89	3533049
Year 3	3950198	1346272	11365090	0.8396	3316662
Year 4	3240676	4586948	14605766	0.7921	2566919
TOTAL			14605766		12666780

The Net Present Value at 6% discount rate is 2647962

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. 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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Plan Spencer 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 Plan Spencer 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 Tough Decisions at Marks and Spencer

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 Plan Spencer 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 Plan Spencer 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	(10018818)	-10018818	-	-
Year 1	3445158	-6573660	3445158	0.8696	2995790
Year 2	3969734	-2603926	7414892	0.7561	3001689
Year 3	3950198	1346272	11365090	0.6575	2597319
Year 4	3240676	4586948	14605766	0.5718	1852867
TOTAL					10447665

The Net NPV after 4 years is 428847

(10447665 - 10018818 )

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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	(10018818)	-10018818	-	-
Year 1	3445158	-6573660	3445158	0.8333	2870965
Year 2	3969734	-2603926	7414892	0.6944	2756760
Year 3	3950198	1346272	11365090	0.5787	2285994
Year 4	3240676	4586948	14605766	0.4823	1562826
TOTAL					9476545

The Net NPV after 4 years is -542273

At 20% discount rate the NPV is negative (9476545 - 10018818 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Plan Spencer 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 Plan Spencer has a NPV value higher than Zero then finance managers at Plan Spencer 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 Plan Spencer, then the stock price of the Plan Spencer 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 Plan Spencer 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.

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Negotiation Strategy of Tough Decisions at Marks and Spencer

References & Further Readings

Robert G. Eccles, George Serafeim, Kyle Armbrester (2018), "Tough Decisions at Marks and Spencer Harvard Business Review Case Study. Published by HBR Publications.