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E-Business Transformation in the Banking Industry: The Case of Citibank 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 E-Business Transformation in the Banking Industry: The Case of Citibank case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. E-Business Transformation in the Banking Industry: The Case of Citibank case study is a Harvard Business School (HBR) case study written by Ali Farhoomand, Davide Lentini. The E-Business Transformation in the Banking Industry: The Case of Citibank (referred as “Bank 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, Technology.

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






Case Description of E-Business Transformation in the Banking Industry: The Case of Citibank Case Study


Citibank reshaped considerably its e-business program after the financial crisis of 2008 focusing on leveraging its geographical reach, rolling out global initiatives to maintain its leadership in treasury and trade services, and becoming even more customer-centric. Citi restructured its R&D centers and its marketing strategy to assist customers in finding solutions rather than selling products. Citi's execution was fast-paced, but the landscape for treasury and trade services was changing rapidly after the financial crisis. Multi-banking became a must and a new solution marketed by SWIFT allowed to multi-bank on the internet at low cost and with greater efficiency than previous solutions. While adoption was slow, the change in the competitive landscape was significant. The data of any bank could now be seen and manipulated through the internet portal of any other bank. Internet portals continued to evolve offering new features and functionalities at product level: Citi updated its CitiDirect BE and TreasuryVision platforms to offer what the market asked for. But seamless bank-corporate integration at technology level was not evolving at the same pace. Corporation and bank data exchanges were inefficient, making a number of treasury tasks labor-intensive. Corporations came to prefer multi-banking platforms after the financial crisis, and were demanding automated integration of bank data into their ERPs. An e-business transformation was on the way. Internet banking portals became multi-banking portals, as did proprietary bank-corporate EDI links like CitiConnect. But it was cloud computing that promised the definitive technological solution for the bank-corporate integration model. The ERP vendor SAP was the first to experiment with a private cloud model and allow direct straight-through processing of each financial transaction sent from the ERP directly to bank middleware. Citi was the first bank to sign up with the project, but its competitors followed. Digitalization of bank services was reaching the next level, and this promised to have significant impact on the banking business model.


Case Authors : Ali Farhoomand, Davide Lentini

Topic : Technology & Operations

Related Areas : Technology




Calculating Net Present Value (NPV) at 6% for E-Business Transformation in the Banking Industry: The Case of Citibank Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10017523) -10017523 - -
Year 1 3463248 -6554275 3463248 0.9434 3267215
Year 2 3974968 -2579307 7438216 0.89 3537707
Year 3 3969809 1390502 11408025 0.8396 3333128
Year 4 3225166 4615668 14633191 0.7921 2554634
TOTAL 14633191 12692684




The Net Present Value at 6% discount rate is 2675161

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.




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. Payback Period
3. Internal Rate of Return
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. Bank 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 Bank 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.






Formula and Steps to Calculate Net Present Value (NPV) of E-Business Transformation in the Banking Industry: The Case of Citibank

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 Bank 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 Bank 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 (10017523) -10017523 - -
Year 1 3463248 -6554275 3463248 0.8696 3011520
Year 2 3974968 -2579307 7438216 0.7561 3005647
Year 3 3969809 1390502 11408025 0.6575 2610214
Year 4 3225166 4615668 14633191 0.5718 1843999
TOTAL 10471380


The Net NPV after 4 years is 453857

(10471380 - 10017523 )








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 (10017523) -10017523 - -
Year 1 3463248 -6554275 3463248 0.8333 2886040
Year 2 3974968 -2579307 7438216 0.6944 2760394
Year 3 3969809 1390502 11408025 0.5787 2297343
Year 4 3225166 4615668 14633191 0.4823 1555346
TOTAL 9499124


The Net NPV after 4 years is -518399

At 20% discount rate the NPV is negative (9499124 - 10017523 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Bank 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 Bank Banking has a NPV value higher than Zero then finance managers at Bank 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 Bank Banking, then the stock price of the Bank 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 Bank 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 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.

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.

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.






Negotiation Strategy of E-Business Transformation in the Banking Industry: The Case of Citibank

References & Further Readings

Ali Farhoomand, Davide Lentini (2018), "E-Business Transformation in the Banking Industry: The Case of Citibank Harvard Business Review Case Study. Published by HBR Publications.


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