Beneficial State Bank: Benefit to All, Harm to None 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 Beneficial State Bank: Benefit to All, Harm to None case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Beneficial State Bank: Benefit to All, Harm to None case study is a Harvard Business School (HBR) case study written by Charles Ewald, Heidi Krauel Patel, Jaclyn C. Foroughi. The Beneficial State Bank: Benefit to All, Harm to None (referred as “Beneficial Bank” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Influence.

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 Beneficial State Bank: Benefit to All, Harm to None Case Study

In the fall of 2017, Beneficial State Bank, a triple bottom line community development bank serving areas of California, Oregon, and Washington, had completed its fourth successive year of normalized profitability while continuing to fulfill its mission of promoting social justice and environmental sustainability. Having grown roughly 20 percent organically by loan and deposit growth annually, as well as through three aligned acquisitions, Beneficial State Bank was well on its way to proving its beneficial banking model as well as the impact of its operations on individuals, communities, and the banking system at large. At the same time, husband and wife creators of the bank, Tom Steyer (MBA '83) and Kat Taylor (JD/MBA '86), found themselves at a crossroads. As the sole providers of capital to the bank during the formation and, as a result of the bank's unique organizational structure, the couple remained the only investors in the bank almost a decade after its founding. With the bank's assets approaching $1 billion, the team envisioned scaling the business for both economic viability and impact to nearly five times the current size in the coming years. In order to achieve this goal, however, the founders would have to consider the introduction of additional investors. This case describes the motivating factors for changing the bank's existing capital structure and includes a discussion of a potential investment option to fulfill these goals. Additional topics include prospective investors, existing capitalization and growth prospects, and the role of mergers and acquisitions.

Case Authors : Charles Ewald, Heidi Krauel Patel, Jaclyn C. Foroughi

Topic : Finance & Accounting

Related Areas : Influence

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Calculating Net Present Value (NPV) at 6% for Beneficial State Bank: Benefit to All, Harm to None Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10010227)	-10010227	-	-
Year 1	3445822	-6564405	3445822	0.9434	3250775
Year 2	3956362	-2608043	7402184	0.89	3521148
Year 3	3955651	1347608	11357835	0.8396	3321241
Year 4	3247066	4594674	14604901	0.7921	2571980
TOTAL			14604901		12665145

The Net Present Value at 6% discount rate is 2654918

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. Profitability Index
3. Net Present Value
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. Beneficial Bank 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 Beneficial Bank 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 Beneficial State Bank: Benefit to All, Harm to None

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 Beneficial Bank 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 Beneficial Bank 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	(10010227)	-10010227	-	-
Year 1	3445822	-6564405	3445822	0.8696	2996367
Year 2	3956362	-2608043	7402184	0.7561	2991578
Year 3	3955651	1347608	11357835	0.6575	2600905
Year 4	3247066	4594674	14604901	0.5718	1856521
TOTAL					10445370

The Net NPV after 4 years is 435143

(10445370 - 10010227 )

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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	(10010227)	-10010227	-	-
Year 1	3445822	-6564405	3445822	0.8333	2871518
Year 2	3956362	-2608043	7402184	0.6944	2747474
Year 3	3955651	1347608	11357835	0.5787	2289150
Year 4	3247066	4594674	14604901	0.4823	1565908
TOTAL					9474049

The Net NPV after 4 years is -536178

At 20% discount rate the NPV is negative (9474049 - 10010227 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Beneficial Bank 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 Beneficial Bank has a NPV value higher than Zero then finance managers at Beneficial Bank 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 Beneficial Bank, then the stock price of the Beneficial Bank 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 Beneficial Bank 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 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 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.

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 Beneficial State Bank: Benefit to All, Harm to None

References & Further Readings

Charles Ewald, Heidi Krauel Patel, Jaclyn C. Foroughi (2018), "Beneficial State Bank: Benefit to All, Harm to None Harvard Business Review Case Study. Published by HBR Publications.