Merging the Brands and Branding the Merger 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 Merging the Brands and Branding the Merger case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Merging the Brands and Branding the Merger case study is a Harvard Business School (HBR) case study written by Richard Ettenson, Jonathan Knowles. The Merging the Brands and Branding the Merger (referred as “Merger Deal” from here on) case study provides evaluation & decision scenario in field of Strategy & Execution. It also touches upon business topics such as - Value proposition, 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 Merging the Brands and Branding the Merger Case Study

This is an MIT Sloan Management Review article. Of the myriad complex decisions that senior executives make before and during a merger, one is mandatory and critical but often given short shrift: the branding of the new corporate entity. When executed effectively, a corporate rebranding can greatly facilitate the merger of the two businesses by sending the right signals to people both inside and outside the organization. In a study of more than 200 mergers and aquisitions completed since 1995 with a transaction value exceeding $250 million, the authors found 10 different strategies for corporate rebranding. The 10 options can be grouped into four main categories that communicate fundamentally different messages: (1) This deal is a merger and we are adopting the stronger brand; (2) this deal is a merger and we are adopting the best of both brands; (3) this deal is a transformational merger and we are creating a new brand; and (4) this deal is simply a portfolio transaction and no brand changes will occur. In any M&A, executives need to select the right strategy with respect to three important constituencies: employees, customers and the investment community.

Case Authors : Richard Ettenson, Jonathan Knowles

Topic : Strategy & Execution

Related Areas : Mergers & acquisitions

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Calculating Net Present Value (NPV) at 6% for Merging the Brands and Branding the Merger Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10017389)	-10017389	-	-
Year 1	3461992	-6555397	3461992	0.9434	3266030
Year 2	3968344	-2587053	7430336	0.89	3531812
Year 3	3951010	1363957	11381346	0.8396	3317344
Year 4	3229497	4593454	14610843	0.7921	2558064
TOTAL			14610843		12673251

The Net Present Value at 6% discount rate is 2655862

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. Profitability Index
2. Net Present Value
3. Payback Period
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. Timing of the expected cash flows – stockholders of Merger Deal 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. Merger Deal 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 Merging the Brands and Branding the Merger

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 Merger Deal 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 Merger Deal 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	(10017389)	-10017389	-	-
Year 1	3461992	-6555397	3461992	0.8696	3010428
Year 2	3968344	-2587053	7430336	0.7561	3000638
Year 3	3951010	1363957	11381346	0.6575	2597853
Year 4	3229497	4593454	14610843	0.5718	1846475
TOTAL					10455395

The Net NPV after 4 years is 438006

(10455395 - 10017389 )

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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	(10017389)	-10017389	-	-
Year 1	3461992	-6555397	3461992	0.8333	2884993
Year 2	3968344	-2587053	7430336	0.6944	2755794
Year 3	3951010	1363957	11381346	0.5787	2286464
Year 4	3229497	4593454	14610843	0.4823	1557435
TOTAL					9484687

The Net NPV after 4 years is -532702

At 20% discount rate the NPV is negative (9484687 - 10017389 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Merger Deal 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 Merger Deal has a NPV value higher than Zero then finance managers at Merger Deal 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 Merger Deal, then the stock price of the Merger Deal 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 Merger Deal 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 key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

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

Understanding of risks involved in 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.

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 Merging the Brands and Branding the Merger

References & Further Readings

Richard Ettenson, Jonathan Knowles (2018), "Merging the Brands and Branding the Merger Harvard Business Review Case Study. Published by HBR Publications.