Southeastern Asset Management Challenges Buyout at Dell 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 Southeastern Asset Management Challenges Buyout at Dell case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Southeastern Asset Management Challenges Buyout at Dell case study is a Harvard Business School (HBR) case study written by Paul M. Healy, Suraj Srinivasan, Aldo Sesia. The Southeastern Asset Management Challenges Buyout at Dell (referred as “Dell Southeastern” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Boards, Financial analysis, Financial management, IT, Mergers & acquisitions, Organizational culture.

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 Southeastern Asset Management Challenges Buyout at Dell Case Study

In late 2012, Michael Dell wants to take Dell Inc., the company he founded, private. Mr. Dell believes that the successful company's transformation from a personal computer (PC) manufacturer to an enterprise solutions and services provider (ESS) is dependent on going private without the short-term results scrutiny public companies face. He and a private equity firm, Silver Lake Partners, have made an offer for the company, which Dell Inc.'s board has accepted. The deal requires the vote of a majority of shareholders. Southeastern Asset Management, an investment firm, and Dell Inc.'s second largest shareholder behind Mr. Dell strongly oppose the deal because the offer is well below what Southeastern believes is Dell Inc.'s intrinsic value. Southeastern, along with activist investor Carl Icahn, wage a campaign to defeat the go-private deal and propose a leveraged recapitalization as an alternative. On several occasions it appears that the deal will be voted down by shareholders, but rule changes made by Dell Inc.'s Board eventually pave the way for Mr. Dell to take the eponymous company private-for a price only slightly higher than the original bid. The case describes the reasons why Mr. Dell wants to take Dell Inc. private, why Southeastern and Icahn oppose the deal, the specifics of both the Dell/Silver Lake bid and of Southeastern's/Icahn's leveraged recapitalization proposals, and the events that took place.

Case Authors : Paul M. Healy, Suraj Srinivasan, Aldo Sesia

Topic : Finance & Accounting

Related Areas : Boards, Financial analysis, Financial management, IT, Mergers & acquisitions, Organizational culture

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Calculating Net Present Value (NPV) at 6% for Southeastern Asset Management Challenges Buyout at Dell Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10003029)	-10003029	-	-
Year 1	3444936	-6558093	3444936	0.9434	3249940
Year 2	3962888	-2595205	7407824	0.89	3526956
Year 3	3972547	1377342	11380371	0.8396	3335427
Year 4	3228408	4605750	14608779	0.7921	2557202
TOTAL			14608779		12669524

The Net Present Value at 6% discount rate is 2666495

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. Internal Rate of Return
2. Net Present Value
3. Payback Period
4. Profitability Index

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. Dell Southeastern 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 Dell Southeastern 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 Southeastern Asset Management Challenges Buyout at Dell

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 Finance & Accounting 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 Dell Southeastern 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 Dell Southeastern 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	(10003029)	-10003029	-	-
Year 1	3444936	-6558093	3444936	0.8696	2995597
Year 2	3962888	-2595205	7407824	0.7561	2996513
Year 3	3972547	1377342	11380371	0.6575	2612014
Year 4	3228408	4605750	14608779	0.5718	1845853
TOTAL					10449976

The Net NPV after 4 years is 446947

(10449976 - 10003029 )

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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	(10003029)	-10003029	-	-
Year 1	3444936	-6558093	3444936	0.8333	2870780
Year 2	3962888	-2595205	7407824	0.6944	2752006
Year 3	3972547	1377342	11380371	0.5787	2298928
Year 4	3228408	4605750	14608779	0.4823	1556910
TOTAL					9478623

The Net NPV after 4 years is -524406

At 20% discount rate the NPV is negative (9478623 - 10003029 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Dell Southeastern 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 Dell Southeastern has a NPV value higher than Zero then finance managers at Dell Southeastern 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 Dell Southeastern, then the stock price of the Dell Southeastern 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 Dell Southeastern 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 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 can impact the cash flow of the project.

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 Southeastern Asset Management Challenges Buyout at Dell

References & Further Readings

Paul M. Healy, Suraj Srinivasan, Aldo Sesia (2018), "Southeastern Asset Management Challenges Buyout at Dell Harvard Business Review Case Study. Published by HBR Publications.