MRKT 690 Week 7 Market Project Valuation Exercise Example

Market Project Valuation Exercise: Net Present Value and a $1.5 Million Marketing Budget Across Six Proposed Projects

Company, Budget and Method

Harbor Point Beverages, the simulation company in this exercise, makes regional juices and sparkling drinks and has asked its marketing team to allocate a budget of $1.5 million for the next fiscal year among six proposals. Each proposal comes with an estimated initial investment and three years of incremental cash flow, the additional cash the company expects the project to generate after its direct costs. Following the company's guidance, cash flows are treated as arriving at the end of each year and discounted at its 10 percent cost of capital. For each project, net present value equals the sum of its discounted cash flows minus its investment; the profitability index is the present value of the cash flows divided by the investment. All figures are in thousands of dollars.

Results

Four projects have positive net present value: the loyalty app relaunch, the sampling program, the flavor launch and, barely, the influencer program. The regional television campaign and the increase in trade promotion would destroy value at the company's cost of capital. Their cash flows look large, but they fall each year, which is typical of promotions whose effect fades once the spending stops, and in present value they fail to recover their cost.

Allocation Under the Budget

Funding all four positive projects would cost $1.65 million, more than the $1.5 million available, so the company must choose. Ranking by profitability index gives the order A, C, D and E. Funding A, C and D uses $1.4 million and produces a combined net present value of $240,000. The alternatives that fit the budget are weaker: A, D and E would cost $1.35 million and produce $194,900, and A, C and E would cost $950,000 and produce $181,700. The best use of the budget is to fund the loyalty app relaunch, the grocery sampling program and the new flavor launch, which together add about $240,000 in value, and to hold the remaining $100,000 rather than force it into a weaker project.

The marketing logic supports the numbers. The loyalty app and sampling program both work on existing and new customers at the point of purchase, and both pay back within two years. The flavor launch is the only growth project in the set, and although its returns come late, it is the one project that could change the brand's position rather than borrow sales from future periods. The rejected projects, the television campaign and the trade promotion increase, would mainly buy short-term volume. Srivastava et al. (1998) argue that marketing creates shareholder value by building market-based assets, such as customer and channel relationships, that accelerate and enhance cash flows, make them less volatile and raise their residual value. The loyalty app and the flavor launch build such assets; a trade promotion that ends after a year leaves little behind.

Assumptions and Limits

Every figure above inherits the quality of the proposals' cash flow forecasts, and forecasts written by the teams that want the money tend to run high. Rust et al. (2004) proposed a framework that links marketing actions to their effects on customers, then to market outcomes and finally to financial results, and they argued that marketers can show how spending adds to shareholder value if they measure each link. The estimates here skip several links: they assume, for example, that the loyalty app will raise repeat purchase rates by the amount the vendor projects. The three-year horizon also understates projects whose benefits last longer. Research on customer value shows how much retention matters to the value of a firm; Gupta et al. (2004) put a value on the customer bases of five firms and showed that lifting retention by a single percentage point added roughly 5 percent to firm value, several times what the same gain in margin achieved and far more than cheaper acquisition did. If the loyalty app improves retention as planned, its true value may be well above the figure in the table.

Sensitivity

Two tests show how robust the choice is. At a 12 percent discount rate, the net present values become $106,900 for the loyalty app, $38,900 for sampling, $33,200 for the flavor launch and negative $3,700 for the influencer program, so the recommended three projects remain positive and the influencer program drops below zero, which supports leaving it unfunded. The flavor launch is the riskiest project, because most of its value comes in year 3. If its third-year cash flow were 20 percent lower, $360,000 instead of $450,000, its net present value at 10 percent would fall by about $67,600 to roughly negative $3,900. The company should therefore fund the launch in stages, committing the second half of its budget only if first-year results meet the plan.

Recommendation and Tracking

The recommended allocation is $400,000 for the loyalty app relaunch, $300,000 for grocery sampling, $700,000 for the flavor launch, released in two stages, and a $100,000 reserve. The reserve could fund a small, measured test of the influencer program, whose estimated value is too close to zero to justify a full commitment. Each funded project should report its actual incremental cash flow each quarter against the estimates in this report, so that next year's allocation rests on results rather than proposals.

References

Gupta, S., Lehmann, D. R., & Stuart, J. A. (2004). Valuing customers. Journal of Marketing Research, 41(1), 7-18. https://doi.org/10.1509/jmkr.41.1.7.25084

Rust, R. T., Ambler, T., Carpenter, G. S., Kumar, V., & Srivastava, R. K. (2004). Measuring marketing productivity: Current knowledge and future directions. Journal of Marketing, 68(4), 76-89. https://doi.org/10.1509/jmkg.68.4.76.42721

Srivastava, R. K., Shervani, T. A., & Fahey, L. (1998). Market-based assets and shareholder value: A framework for analysis. Journal of Marketing, 62(1), 2-18. https://doi.org/10.1177/002224299806200102