9/6/2019 NPV Solution Wal-Mart Stores, Inc.

(A)

WAL-MART STORES, INC. (A) NET PRESENT VALUE

(NPV)
CALCULATING NET PRESENT VALUE (NPV) AT 6%
Cumulative Discount Rate Discounted
Years Cash Flow Net Cash Flow
Cash Flow @6% Cash Flows
Year 0 (10003329) -10003329 - -
Year 1 3465295 -6538034 3465295 0.9434 3269146
Year 2 3972920 -2565114 7438215 0.89 3535885
Year 3 3950141 1385027 11388356 0.8396 3316615
Year 4 3223241 4608268 14611597 0.7921 2553109
TOTAL 14611597 12674754

THE NET PRESENT VALUE AT 6% DISCOUNT RATE IS 2671425

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.

METHODS OF CAPITAL BUDGETING

There are four types of capital budgeting techniques that are widely used in the corporate
world –

1. Payback Period
2. Internal Rate of Return

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3. Profitability Index
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. Timing of the expected cash flows – stockholders of Stores Mart 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. Stores Mart shareholders have preference for diversified projects
investment rather than prospective high income from a single capital intensive project.

CASE STUDY OVERVIEW

This is a Thunderbird Case Study.Wal-Mart Stores, Inc. is one of the classic stores in American
business. This case, which focuses on the emergence and development of the firm between the
mid-1960s and 1990, allows the student to derive a relatively clear understanding of how Sam
Walton et al. were able to grow the firm from a single location to one with 1,525 stores and $26
billion sales.

AUTHORS :: M. EDGAR BARRETT, MITCHELL W. SLAPE

CATEGORY :: STRATEGY & EXECUTION

KEY WORDS ::

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WHAT IS NET PRESENT VALUE (NPV) ? HOW IT IMPACTS FINANCIAL

DECISIONS REGARDING PROJECT 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

FORMULA AND STEPS TO CALCULATE NET PRESENT VALUE (NPV)

OF WAL-MART STORES, INC. (A)
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 STRATEGY & EXECUTION 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
Stores Mart 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.

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To overcome such scenarios managers at Stores Mart 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.

Cumulative Discount Rate Discounted

Years Cash Flow Net Cash Flow
Cash Flow @ 15 % Cash Flows
Year 0 (10003329) -10003329 - -
Year 1 3465295 -6538034 3465295 0.8696 3013300
Year 2 3972920 -2565114 7438215 0.7561 3004098
Year 3 3950141 1385027 11388356 0.6575 2597282
Year 4 3223241 4608268 14611597 0.5718 1842899
TOTAL 10457579

THE NET NPV AFTER 4 YEARS IS 454250

(10457579 - 10003329 )

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%.

Cumulative Discount Rate Discounted

Years Cash Flow Net Cash Flow
Cash Flow @ 20 % Cash Flows
Year 0 (10003329) -10003329 - -
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Cumulative Discount Rate Discounted

Years Cash Flow Net Cash Flow
Cash Flow @ 20 % Cash Flows
Year 1 3465295 -6538034 3465295 0.8333 2887746
Year 2 3972920 -2565114 7438215 0.6944 2758972
Year 3 3950141 1385027 11388356 0.5787 2285961
Year 4 3223241 4608268 14611597 0.4823 1554418
TOTAL 9487097

THE NET NPV AFTER 4 YEARS IS -516232

At 20% discount rate the NPV is negative (9487097 - 10003329 ) so ideally we can't select the
project if macro and micro factors don't allow financial managers of Stores Mart 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 Stores Mart has a NPV value higher than
Zero then finance managers at Stores Mart 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 Stores Mart, then the stock price of the Stores Mart 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

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Project selection is often a far more complex decision than just choosing it based on the NPV
number. Finance managers at Stores Mart 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 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.

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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