OCBC Versus Hedge Fund: Acquisition of Wing Hang Bank 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 OCBC Versus Hedge Fund: Acquisition of Wing Hang Bank case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. OCBC Versus Hedge Fund: Acquisition of Wing Hang Bank case study is a Harvard Business School (HBR) case study written by Emir Hrnjic, Han Dong. The OCBC Versus Hedge Fund: Acquisition of Wing Hang Bank (referred as “Singapore Hong” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. 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 OCBC Versus Hedge Fund: Acquisition of Wing Hang Bank Case Study

A Singapore-based financial services company, the second largest lender in Southeast Asia, offered to acquire a Hong Kong bank, the eighth largest lender in the country, for a premium price per share. Three months later, a multi-billion hedge fund firm based in the United States had accumulated close to 8 per cent of the Hong Kong bank's shares. According to Hong Kong's securities law, the Singapore-based financial institution would have to acquire 90 per cent of the Hong Kong bank's shares to successfully take the bank private, and there were only 25 days left for the company to meet this requirement. The hedge fund firm's unspoken message was clear: raise your bid price to buy our shares or we will keep the company public at your expense. Emir HrnjiA‡ is affiliated with National University of Singapore. Han Dong is affiliated with National University of Singapore.

Case Authors : Emir Hrnjic, Han Dong

Topic : Finance & Accounting

Related Areas :

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Calculating Net Present Value (NPV) at 6% for OCBC Versus Hedge Fund: Acquisition of Wing Hang Bank Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10025548)	-10025548	-	-
Year 1	3463854	-6561694	3463854	0.9434	3267787
Year 2	3955412	-2606282	7419266	0.89	3520303
Year 3	3961448	1355166	11380714	0.8396	3326108
Year 4	3240785	4595951	14621499	0.7921	2567005
TOTAL			14621499		12681203

The Net Present Value at 6% discount rate is 2655655

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. Profitability Index
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Singapore Hong 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 Singapore Hong 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 OCBC Versus Hedge Fund: Acquisition of Wing Hang Bank

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 Singapore Hong 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 Singapore Hong 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	(10025548)	-10025548	-	-
Year 1	3463854	-6561694	3463854	0.8696	3012047
Year 2	3955412	-2606282	7419266	0.7561	2990860
Year 3	3961448	1355166	11380714	0.6575	2604716
Year 4	3240785	4595951	14621499	0.5718	1852929
TOTAL					10460552

The Net NPV after 4 years is 435004

(10460552 - 10025548 )

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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	(10025548)	-10025548	-	-
Year 1	3463854	-6561694	3463854	0.8333	2886545
Year 2	3955412	-2606282	7419266	0.6944	2746814
Year 3	3961448	1355166	11380714	0.5787	2292505
Year 4	3240785	4595951	14621499	0.4823	1562879
TOTAL					9488742

The Net NPV after 4 years is -536806

At 20% discount rate the NPV is negative (9488742 - 10025548 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Singapore Hong 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 Singapore Hong has a NPV value higher than Zero then finance managers at Singapore Hong 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 Singapore Hong, then the stock price of the Singapore Hong 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 Singapore Hong 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 will be a multi year spillover effect of various taxation regulations.

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.

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 OCBC Versus Hedge Fund: Acquisition of Wing Hang Bank

References & Further Readings

Emir Hrnjic, Han Dong (2018), "OCBC Versus Hedge Fund: Acquisition of Wing Hang Bank Harvard Business Review Case Study. Published by HBR Publications.