HSBC Credit Card Rewards Program 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 HSBC Credit Card Rewards Program case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. HSBC Credit Card Rewards Program case study is a Harvard Business School (HBR) case study written by Robert J. Fisher. The HSBC Credit Card Rewards Program (referred as “Hsbc Redemption” from here on) case study provides evaluation & decision scenario in field of Sales & Marketing. It also touches upon business topics such as - Value proposition, .

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 HSBC Credit Card Rewards Program Case Study

Around 1994, competition in the credit card market was based on price (i.e., interest rates and annual fees). After Chase and American Express launched bonus point programs in 1993, HSBC was forced to follow in 1994. The original program was targeted at high-income consumers as with luxury brand redemption items. Competition reacted and consumers quickly learned to expect a points program as a standard feature. Again, HSBC differentiated their credit card products by adding a wider range of redemption items, and lowering redemptions levels. Problems emerged in 1997-1998 as the program became a source of complaints because of operational difficulties in fulfillment and a lack of competitive advantage in the marketplace. In 1999, HBSC's credit card was rated poorly, largely because of the problems with the bonus point system. Research was used to understand consumers and revitalize the program. Significant changes were made in the features, improved operations and an improved selection of redemption items. By 2002, the program was rated as one of the best in the industry. The challenge is, "Where does HSBC go from here?"

Case Authors : Robert J. Fisher

Topic : Sales & Marketing

Related Areas :

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Calculating Net Present Value (NPV) at 6% for HSBC Credit Card Rewards Program Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012340)	-10012340	-	-
Year 1	3469949	-6542391	3469949	0.9434	3273537
Year 2	3971667	-2570724	7441616	0.89	3534769
Year 3	3948159	1377435	11389775	0.8396	3314950
Year 4	3240572	4618007	14630347	0.7921	2566837
TOTAL			14630347		12690093

The Net Present Value at 6% discount rate is 2677753

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

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Hsbc Redemption shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Hsbc Redemption have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of HSBC Credit Card Rewards Program

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 Sales & Marketing 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 Hsbc Redemption 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 Hsbc Redemption 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	(10012340)	-10012340	-	-
Year 1	3469949	-6542391	3469949	0.8696	3017347
Year 2	3971667	-2570724	7441616	0.7561	3003151
Year 3	3948159	1377435	11389775	0.6575	2595979
Year 4	3240572	4618007	14630347	0.5718	1852808
TOTAL					10469284

The Net NPV after 4 years is 456944

(10469284 - 10012340 )

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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	(10012340)	-10012340	-	-
Year 1	3469949	-6542391	3469949	0.8333	2891624
Year 2	3971667	-2570724	7441616	0.6944	2758102
Year 3	3948159	1377435	11389775	0.5787	2284814
Year 4	3240572	4618007	14630347	0.4823	1562776
TOTAL					9497316

The Net NPV after 4 years is -515024

At 20% discount rate the NPV is negative (9497316 - 10012340 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Hsbc Redemption 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 Hsbc Redemption has a NPV value higher than Zero then finance managers at Hsbc Redemption 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 Hsbc Redemption, then the stock price of the Hsbc Redemption 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 Hsbc Redemption 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 –

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.

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.

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 HSBC Credit Card Rewards Program

References & Further Readings

Robert J. Fisher (2018), "HSBC Credit Card Rewards Program Harvard Business Review Case Study. Published by HBR Publications.