Furman Selz LLC (A): A Tale of Two Acquisitions 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 Furman Selz LLC (A): A Tale of Two Acquisitions case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Furman Selz LLC (A): A Tale of Two Acquisitions case study is a Harvard Business School (HBR) case study written by Nancy Dean Beaulieu, Boris Groysberg, Kyle T. Doherty. The Furman Selz LLC (A): A Tale of Two Acquisitions (referred as “Ing Furman” 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 analysis, Human resource management, Leadership, 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

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Case Description of Furman Selz LLC (A): A Tale of Two Acquisitions Case Study

Profiles a firm that was reacquired by two companies with different degrees of success. Highlights integration challenges present in acquisition deals when the primary assets of the target are human capital. Focuses on Furman Selz's acquisition by Xerox in 1987; its return to a private company in 1993; and a second acquisition, by ING, in 1997. In particular, provides the opportunity to evaluate five major corporate transitions: the initial launching as an independent firm, Furman Selz, in 1973; the shift to professional management in 1983-1986; the Xerox acquisition in 1987; the MBO in 1993; and the ING acquisition in 1997. Presents the transactions from multiple points of view: the founders and their associates; the professional managers brought in to advance the firm to the next level; the acquired firm under both Xerox and ING; and Xerox and ING themselves.

Case Authors : Nancy Dean Beaulieu, Boris Groysberg, Kyle T. Doherty

Topic : Organizational Development

Related Areas : Financial analysis, Human resource management, Leadership, Mergers & acquisitions

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Calculating Net Present Value (NPV) at 6% for Furman Selz LLC (A): A Tale of Two Acquisitions Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10005005)	-10005005	-	-
Year 1	3443520	-6561485	3443520	0.9434	3248604
Year 2	3957486	-2603999	7401006	0.89	3522148
Year 3	3971700	1367701	11372706	0.8396	3334716
Year 4	3222817	4590518	14595523	0.7921	2552773
TOTAL			14595523		12658241

The Net Present Value at 6% discount rate is 2653236

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. Profitability Index
3. Internal Rate of Return
4. Payback Period

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

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Formula and Steps to Calculate Net Present Value (NPV) of Furman Selz LLC (A): A Tale of Two Acquisitions

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 Ing Furman 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 Ing Furman 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	(10005005)	-10005005	-	-
Year 1	3443520	-6561485	3443520	0.8696	2994365
Year 2	3957486	-2603999	7401006	0.7561	2992428
Year 3	3971700	1367701	11372706	0.6575	2611457
Year 4	3222817	4590518	14595523	0.5718	1842656
TOTAL					10440906

The Net NPV after 4 years is 435901

(10440906 - 10005005 )

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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	(10005005)	-10005005	-	-
Year 1	3443520	-6561485	3443520	0.8333	2869600
Year 2	3957486	-2603999	7401006	0.6944	2748254
Year 3	3971700	1367701	11372706	0.5787	2298438
Year 4	3222817	4590518	14595523	0.4823	1554213
TOTAL					9470505

The Net NPV after 4 years is -534500

At 20% discount rate the NPV is negative (9470505 - 10005005 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ing Furman 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 Ing Furman has a NPV value higher than Zero then finance managers at Ing Furman 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 Ing Furman, then the stock price of the Ing Furman 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 Ing Furman 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 can impact the cash flow of the project.

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 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.

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Negotiation Strategy of Furman Selz LLC (A): A Tale of Two Acquisitions

References & Further Readings

Nancy Dean Beaulieu, Boris Groysberg, Kyle T. Doherty (2018), "Furman Selz LLC (A): A Tale of Two Acquisitions Harvard Business Review Case Study. Published by HBR Publications.