Deal Making in Troubled Waters: The ABN AMRO Takeover 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 Deal Making in Troubled Waters: The ABN AMRO Takeover case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Deal Making in Troubled Waters: The ABN AMRO Takeover case study is a Harvard Business School (HBR) case study written by Didier Cossin, Luc Keuleneer. The Deal Making in Troubled Waters: The ABN AMRO Takeover (referred as “Abn Amro” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, International business, Leadership, Mergers & acquisitions, Organizational structure, Risk management.

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 Deal Making in Troubled Waters: The ABN AMRO Takeover Case Study

In a letter to ABN AMRO in February 2007, TCI, a British hedge fund with a small stake in ABN AMRO, stated: "We believe that it would be in the interests of all shareholders, other stakeholders and ABN AMRO for the Managing Board of ABN AMRO to actively pursue the potential break up, spin-off, sale or merger of its various businesses (or as a whole)...". Eight months later, after a head-to-head battle with Barclays, the bank was finally sold to a Royal Bank of Scotland-led consortium, which included Banco Santander of Spain and Fortis, the Belgo-Dutch group. It was the largest financial services transaction ever and the first time that bidders had attempted to break up a large lender. This case looks at the events that led up to the takeover and examines some of the strategic decisions of the recent past which may have triggered the process. It discusses the financing and timing of the deal in the turbulent financial markets of 2007 and raises questions about the future. What were the risks of splitting the bank? Could this complex task be achieved successfully? Learning objectives: This integrative case gives participants an overview of the different aspects of a takeover: finance and control, integrated risk management, strategy. Issues for discussion include strategic lessons for the future of banking in Europe and worldwide; strengths and weaknesses of the two bids regarding valuation, synergies, timing, deal structure, concerns regarding integration planning and implementation.

Case Authors : Didier Cossin, Luc Keuleneer

Topic : Strategy & Execution

Related Areas : International business, Leadership, Mergers & acquisitions, Organizational structure, Risk management

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Calculating Net Present Value (NPV) at 6% for Deal Making in Troubled Waters: The ABN AMRO Takeover Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016439)	-10016439	-	-
Year 1	3472492	-6543947	3472492	0.9434	3275936
Year 2	3980725	-2563222	7453217	0.89	3542831
Year 3	3937994	1374772	11391211	0.8396	3306416
Year 4	3243297	4618069	14634508	0.7921	2568995
TOTAL			14634508		12694178

The Net Present Value at 6% discount rate is 2677739

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. Payback Period
2. Profitability Index
3. Internal Rate of Return
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 Abn Amro 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. Abn Amro 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 Deal Making in Troubled Waters: The ABN AMRO Takeover

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 Strategy & Execution 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 Abn Amro 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 Abn Amro 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	(10016439)	-10016439	-	-
Year 1	3472492	-6543947	3472492	0.8696	3019558
Year 2	3980725	-2563222	7453217	0.7561	3010000
Year 3	3937994	1374772	11391211	0.6575	2589295
Year 4	3243297	4618069	14634508	0.5718	1854366
TOTAL					10473219

The Net NPV after 4 years is 456780

(10473219 - 10016439 )

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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	(10016439)	-10016439	-	-
Year 1	3472492	-6543947	3472492	0.8333	2893743
Year 2	3980725	-2563222	7453217	0.6944	2764392
Year 3	3937994	1374772	11391211	0.5787	2278932
Year 4	3243297	4618069	14634508	0.4823	1564090
TOTAL					9501157

The Net NPV after 4 years is -515282

At 20% discount rate the NPV is negative (9501157 - 10016439 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Abn Amro 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 Abn Amro has a NPV value higher than Zero then finance managers at Abn Amro 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 Abn Amro, then the stock price of the Abn Amro 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 Abn Amro 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 key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What can impact the cash flow of the project.

Understanding of risks involved in the project.

What will be a multi year spillover effect of various taxation regulations.

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.

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 Deal Making in Troubled Waters: The ABN AMRO Takeover

References & Further Readings

Didier Cossin, Luc Keuleneer (2018), "Deal Making in Troubled Waters: The ABN AMRO Takeover Harvard Business Review Case Study. Published by HBR Publications.