Question

Hello, my lecturer has asked us to do capital budgeting based on this. Required:

a) NPV

b) IRR

C) Payback period and analysis

Walmart, the world’s largest retailer, has finally confirmed that it is making a $16 billion investment into Flipkart for a 77 percent share of the online retailer. Tencent, Tiger Global, Microsoft, Accel and Flipkart co-founder Binny Bansal will continue to be investors in the company with this deal. The investment will value Flipkart — India’s biggest online retailer with 54 million active customers and projected gross merchandise value of $7.5 billion for 2018 — at $20.8 billion when the deal closes. That close is expected to happen later this year after getting regulatory approval.

The investment in Flipkart becomes the biggest-ever that Walmart has made in its history, supplanting Asda in the UK (which it last week partially divested). Walmart said that it intends to keep Flipkart as a distinctive brand and even help usher the company towards a “publicly-listed, majority-owned subsidiary” in the future. Right now Flipkart operates at a loss as it pursues growth.

Flipkart will give Walmart a big step up in its business in Asia by helping it better tap the region’s second-largest market after China, and one of the world’s fastest-growing economies. Walmart India already has 21 Best Price cash-and-carry stores and one fulfillment center in 19 cities across nine states in India, and it said that more than 95 percent of sourcing coming from India. Walmart said that Krish Iyer, president and chief executive officer of Walmart India, will continue to lead that business. The bigger company has been divesting of some of its international operations at the same time that it is beefing up in India. Most recently, it announced a sale of a majority ownership of Asda in the UK to Sainsbury’s.

It will also give Walmart an advance in its wider e-commerce ambitions, which it has been pursuing at an aggressive pace in a bid to rival the e-commerce Amazon — which not only has been moving into Walmart’s brick-and-mortar territory, but has put a lot of investment specifically into growing its business in India.

“India is one of the most attractive retail markets in the world, given its size and growth rate, and our investment is an opportunity to partner with the company that is leading transformation of eCommerce in the market,” said Doug McMillon, Walmart’s president and chief executive officer in a statement. “As a company, we are transforming globally to meet and exceed the needs of customers and we look forward to working with Flipkart to grow in this critical market. We are also excited to be doing this with Tencent, Tiger Global and Microsoft, which will be key strategic and technology partners. We are confident this group will provide Flipkart with enhanced strategic and competitive advantage. Our investment will benefit India providing quality, affordable goods for customers, while creating new skilled jobs and fresh opportunities for small suppliers, farmers and women entrepreneurs.”

Walmart’s stake — provided it gets regulatory approval — sets up an interesting scenario in India, where now the two biggest e-commerce (and overall?) retailers will be controlled by US companies, something we predicted could happen. The competitive implications for smaller, homegrown startups will be tough, and it will be worth watching how (and if) local regulators respond to that state of affairs.

One detail that might affect that is how Walmart opens the investment to other parties: the company noted in its announcement that “Walmart and Flipkart are also in discussions with additional potential investors who may join the round, which could result in Walmart’s investment stake moving lower after the transaction is complete.” Regardless, Walmart said that it will keep “clear majority ownership.”

Tencent and Tiger Global will keep their seats on the Flipkart board, with new members from Walmart. “The final make-up of the board has yet to be determined, but it will also include independent members,” Walmart said. “The board will work to maintain Flipkart’s core values and entrepreneurial spirit, while ensuring it has strategic and competitive advantages.”

The deal comes after many months of speculation about a tie-up between Flipkart and Walmart, which reached a fever pitch this morning when Softbank CEO Masayoshi Son accidentally let the news of the finalised deal slip out in an investor presentation. He termed it an “acquisition” and sure enough, Softbank is selling its stake in the transaction, so it has exited the investment, one of its biggest in India to date.

Walmart’s stake in Flipkart also sets up India as the latest battleground between the retailer and Amazon. Amazon also had been rumored to be interested in taking a stake in Flipkart as recently as last week. Amazon has already invested billions into its operations in India — a move that had already heightened competition, impacted e-commerce operators’ margins, and had directly impacted Flipkart’s prospects (a 2017 investment was made as a “downround” for example).

This should see a huge infusion of investment into the operations, with Flipkart getting an extra boost from Walmart’s immense purchasing power and logistics muscle. Walmart said that its investment includes $2 billion of new equity funding that will go towards that growth.

“This investment is of immense importance for India and will help fuel our ambition to deepen our connection with buyers and sellers and to create the next wave of retail in India,” said Binny Bansal, Flipkart’s co-founder and group chief executive officer. “While eCommerce is still a relatively small part of retail in India, we see great potential to grow. Walmart is the ideal partner for the next phase of our journey, and we look forward to working together in the years ahead to bring our strengths and learnings in retail and eCommerce to the fore.”

Walmart said it plans to finance the investment with a combination of newly issued debt and cash on hand. After the deal closes, Flipkart’s financials will be reported as part of Walmart’s International business segment. “If the transaction were to close at the end of the second quarter of this fiscal year, Walmart expects a negative impact to FY19 EPS of approximately $0.25 to $0.30, which includes incremental interest expense related to the investment.

Answer 1

Capital budgeting is a technique for evaluating big investment projects. Net Present Value(NPV), Benefit to Cost Ratio, Internal Rate of Return (IRR), Payback Period and AccountingRate of Return are some prominent capital budgeting techniques widely used in the finance arena. A project is passed for implementation after it is approved by these techniques.

Net present value (NPV) technique is a well-known method for evaluating investment projects or proposals. In this technique or method, the present value of all the future cash flows whether negative (expenses) or positive (revenues) are calculated using an appropriate discounting rate and added. From this sum, the initial outlay is deducted to find out the profit in present terms. If the figure is positive, the techniques show a green signal to the project and vice versa. This figure is called the net present value (NPV).

Suppose, our proposed investment is $100 million and present value (PV) of future cash flows come to be $120 million. The NPV would be $20 million and hence, the project should be undertaken. If the PV is $80 million, the NPV would be negative $20, the project is not advisable in this case.

INTERNAL RATE OF RETURN

This method is also a well-known method of evaluation. This has a severe connection with the first method i.e. Net Present Value (NPV). In the NPV method, the discounting rate is assumed to have known to the evaluator. On the contrary, the rate of discounting is not known in this method of Internal Rate of Return (IRR). IRR is found out by equating the NPV equal to 0 with an unknown variable as the discounting rate. This discounting rate is found out using trial and error method or extrapolating and interpolating methods and it is known as Internal Rate of Return (IRR). For evaluation purpose, IRR is compared with the cost of capital of the organization. If the IRR is greater than a cost of capital, the project should be accepted and vice versa.

PAYBACK PERIOD (PBP)

Payback period is the method of evaluation where no discounting of cash flow comes into play. The term ‘payback period’ is the period during which the initial outlay is covered by the revenues. Suppose an initial outlay is $100 million and the revenue stream is $40 for the first 4 years. Then, the payback period is 2.5 years. Essentially, in 2.5 years, the entrepreneur gets his investment back and revenue after this period is the profit for him.