Integration of Wachovia and Golden West (A) 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 Integration of Wachovia and Golden West (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Integration of Wachovia and Golden West (A) case study is a Harvard Business School (HBR) case study written by L.J. Bourgeois, Dave Maher, Matt Jackson, Adam Schwarzschild. The Integration of Wachovia and Golden West (A) (referred as “Golden Wachovia” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Financial markets, Growth strategy, Mergers & acquisitions.

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

Case Description of Integration of Wachovia and Golden West (A) Case Study

In July 2007, Wachovia Corporation's CEO is pleased with a report that shows the firm's record-setting second quarter results. In the past three months, Wachovia has doubled its earnings and posted record revenues, mostly attributable to the large consumer real-estate loans related to the Golden West Financial acquisition that has contributed to the bank's growth. The transition of Golden West into Wachovia's platform had been quick and smooth, despite their cultural, geographic, and product-offering differences. The CEO was excited that the acquisition provided new opportunities for lending in what were perceived as less risky markets, particularly single-family home mortgages with adjustable rates. But he wondered if there were any adjustments necessary to extract ultimate value from Golden West.

Case Authors : L.J. Bourgeois, Dave Maher, Matt Jackson, Adam Schwarzschild

Topic : Organizational Development

Related Areas : Financial markets, Growth strategy, Mergers & acquisitions

Calculating Net Present Value (NPV) at 6% for Integration of Wachovia and Golden West (A) Case Study

Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Cash Flows
Year 0 (10028394) -10028394 - -
Year 1 3444079 -6584315 3444079 0.9434 3249131
Year 2 3966395 -2617920 7410474 0.89 3530077
Year 3 3964315 1346395 11374789 0.8396 3328515
Year 4 3225042 4571437 14599831 0.7921 2554535
TOTAL 14599831 12662259

The Net Present Value at 6% discount rate is 2633865

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.

Capital Budgeting Approaches

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
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 Golden Wachovia 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. Golden Wachovia shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.

Formula and Steps to Calculate Net Present Value (NPV) of Integration of Wachovia and Golden West (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 Organizational Development 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 Golden Wachovia 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 Golden Wachovia 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 %
Cash Flows
Year 0 (10028394) -10028394 - -
Year 1 3444079 -6584315 3444079 0.8696 2994851
Year 2 3966395 -2617920 7410474 0.7561 2999164
Year 3 3964315 1346395 11374789 0.6575 2606601
Year 4 3225042 4571437 14599831 0.5718 1843928
TOTAL 10444545

The Net NPV after 4 years is 416151

(10444545 - 10028394 )

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 %
Cash Flows
Year 0 (10028394) -10028394 - -
Year 1 3444079 -6584315 3444079 0.8333 2870066
Year 2 3966395 -2617920 7410474 0.6944 2754441
Year 3 3964315 1346395 11374789 0.5787 2294164
Year 4 3225042 4571437 14599831 0.4823 1555286
TOTAL 9473957

The Net NPV after 4 years is -554437

At 20% discount rate the NPV is negative (9473957 - 10028394 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Golden Wachovia 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 Golden Wachovia has a NPV value higher than Zero then finance managers at Golden Wachovia 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 Golden Wachovia, then the stock price of the Golden Wachovia 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 Golden Wachovia 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 will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

What can impact the cash flow of 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.

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.

References & Further Readings

L.J. Bourgeois, Dave Maher, Matt Jackson, Adam Schwarzschild (2018), "Integration of Wachovia and Golden West (A) Harvard Business Review Case Study. Published by HBR Publications.