FleetBoston Financial: Online Banking, Portuguese Version 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 FleetBoston Financial: Online Banking, Portuguese Version case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. FleetBoston Financial: Online Banking, Portuguese Version case study is a Harvard Business School (HBR) case study written by Frances X. Frei, Hanna Rodriguez-Farrar. The FleetBoston Financial: Online Banking, Portuguese Version (referred as “Fleetboston Banking” from here on) case study provides evaluation & decision scenario in field of Technology & Operations. It also touches upon business topics such as - Value proposition, Competition, Customers, Disruptive innovation, Entrepreneurship, Internet, IT, Operations 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 FleetBoston Financial: Online Banking, Portuguese Version Case Study

As the ninth largest bank holding company in the United States in 2000, FleetBoston Financial Corp. provided a myriad of financial services, including retail banking, loan origination, and brokerage accounts. This case explores how FleetBoston responded to the Internet and the rise of new competition from both within and outside the banking industry. The majority of the case acquaints students with how customers interact with financial services, how these firms make money, and what are their challenges and opportunities. The majority of retail banking customers are unprofitable, making for a unique operating environment in which innovations are consistently aimed at reducing costs. Because customer behavior contributes directly to costs, innovations center on providing lower cost channels for customer transactions. Unfortunately, each new channel increases overall costs, and banks are still faced with reducing costs. In addition, the Internet has given rise to new competitors, many with lower cost structures and revenue potential outside banking.

Case Authors : Frances X. Frei, Hanna Rodriguez-Farrar

Topic : Technology & Operations

Related Areas : Competition, Customers, Disruptive innovation, Entrepreneurship, Internet, IT, Operations management

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Calculating Net Present Value (NPV) at 6% for FleetBoston Financial: Online Banking, Portuguese Version Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012857)	-10012857	-	-
Year 1	3459429	-6553428	3459429	0.9434	3263612
Year 2	3953006	-2600422	7412435	0.89	3518161
Year 3	3951659	1351237	11364094	0.8396	3317889
Year 4	3223084	4574321	14587178	0.7921	2552984
TOTAL			14587178		12652647

The Net Present Value at 6% discount rate is 2639790

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. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Fleetboston Banking 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 Fleetboston Banking 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 FleetBoston Financial: Online Banking, Portuguese Version

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 Technology & Operations 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 Fleetboston Banking 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 Fleetboston Banking 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	(10012857)	-10012857	-	-
Year 1	3459429	-6553428	3459429	0.8696	3008199
Year 2	3953006	-2600422	7412435	0.7561	2989040
Year 3	3951659	1351237	11364094	0.6575	2598280
Year 4	3223084	4574321	14587178	0.5718	1842809
TOTAL					10438328

The Net NPV after 4 years is 425471

(10438328 - 10012857 )

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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	(10012857)	-10012857	-	-
Year 1	3459429	-6553428	3459429	0.8333	2882858
Year 2	3953006	-2600422	7412435	0.6944	2745143
Year 3	3951659	1351237	11364094	0.5787	2286840
Year 4	3223084	4574321	14587178	0.4823	1554342
TOTAL					9469182

The Net NPV after 4 years is -543675

At 20% discount rate the NPV is negative (9469182 - 10012857 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Fleetboston Banking 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 Fleetboston Banking has a NPV value higher than Zero then finance managers at Fleetboston Banking 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 Fleetboston Banking, then the stock price of the Fleetboston Banking 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 Fleetboston Banking 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.

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.

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

What can impact the cash flow of the project.

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 FleetBoston Financial: Online Banking, Portuguese Version

References & Further Readings

Frances X. Frei, Hanna Rodriguez-Farrar (2018), "FleetBoston Financial: Online Banking, Portuguese Version Harvard Business Review Case Study. Published by HBR Publications.