Unlocking Value at CSX: Responding to Requests from Mantle Ridge 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 Unlocking Value at CSX: Responding to Requests from Mantle Ridge case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Unlocking Value at CSX: Responding to Requests from Mantle Ridge case study is a Harvard Business School (HBR) case study written by Stephen R. Foerster, Ken Mark. The Unlocking Value at CSX: Responding to Requests from Mantle Ridge (referred as “Csx Mantle” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Financial analysis.

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 Unlocking Value at CSX: Responding to Requests from Mantle Ridge Case Study

In 2017, hedge fund Mantle Ridge acquired less than 5 per cent of the stock of CSX Corporation (CSX) and made demands for board representation as well as the installation of a new chief executive officer (CEO) of CSX. This new CEO had abruptly resigned from Canadian Pacific (CP) and joined forces with Mantle Ridge at the time the fund announced its activist position in CSX. On February 14, 2017, CSX management announced a special meeting and shareholders' vote to respond to Mantle Ridge's demands, which included a compensation package for this new CEO, estimated at $300 million. In light of the improvements at CP, could the same model be implemented successfully at CSX? If so, was the proposed compensation package for an incoming CEO justified? The chief investment officer of a large U.S. pension fund, has been asked to vote at the upcoming meeting and faces two main questions: Should she vote in favour of approving the package? Alternatively, should she sell CSX stock now?

Case Authors : Stephen R. Foerster, Ken Mark

Topic : Finance & Accounting

Related Areas : Financial analysis

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Calculating Net Present Value (NPV) at 6% for Unlocking Value at CSX: Responding to Requests from Mantle Ridge Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10009172)	-10009172	-	-
Year 1	3459116	-6550056	3459116	0.9434	3263317
Year 2	3956841	-2593215	7415957	0.89	3521574
Year 3	3960349	1367134	11376306	0.8396	3325185
Year 4	3241196	4608330	14617502	0.7921	2567331
TOTAL			14617502		12677408

The Net Present Value at 6% discount rate is 2668236

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. Internal Rate of Return
3. Payback Period
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. Timing of the expected cash flows – stockholders of Csx Mantle 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. Csx Mantle 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 Unlocking Value at CSX: Responding to Requests from Mantle Ridge

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 Csx Mantle 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 Csx Mantle 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	(10009172)	-10009172	-	-
Year 1	3459116	-6550056	3459116	0.8696	3007927
Year 2	3956841	-2593215	7415957	0.7561	2991940
Year 3	3960349	1367134	11376306	0.6575	2603994
Year 4	3241196	4608330	14617502	0.5718	1853164
TOTAL					10457025

The Net NPV after 4 years is 447853

(10457025 - 10009172 )

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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	(10009172)	-10009172	-	-
Year 1	3459116	-6550056	3459116	0.8333	2882597
Year 2	3956841	-2593215	7415957	0.6944	2747806
Year 3	3960349	1367134	11376306	0.5787	2291869
Year 4	3241196	4608330	14617502	0.4823	1563077
TOTAL					9485348

The Net NPV after 4 years is -523824

At 20% discount rate the NPV is negative (9485348 - 10009172 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Csx Mantle 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 Csx Mantle has a NPV value higher than Zero then finance managers at Csx Mantle 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 Csx Mantle, then the stock price of the Csx Mantle 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 Csx Mantle 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.

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.

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 Unlocking Value at CSX: Responding to Requests from Mantle Ridge

References & Further Readings

Stephen R. Foerster, Ken Mark (2018), "Unlocking Value at CSX: Responding to Requests from Mantle Ridge Harvard Business Review Case Study. Published by HBR Publications.