Minsheng Bank: Penetrating The US Market Through Acquisition 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 Minsheng Bank: Penetrating The US Market Through Acquisition case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Minsheng Bank: Penetrating The US Market Through Acquisition case study is a Harvard Business School (HBR) case study written by Ricky Lai, Gerald Yong Gao, Jiangyong Lu, Hung Gay Fung. The Minsheng Bank: Penetrating The US Market Through Acquisition (referred as “Minsheng Ucbh” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Growth strategy, International business, Mergers & acquisitions, Risk 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 Minsheng Bank: Penetrating The US Market Through Acquisition Case Study

Founded in 1996, China Minsheng Banking Corporation Limited ("Minsheng") was the first private commercial bank in China. By 2006, Minsheng had acquired almost US$130 billion in total assets and established almost 330 banking offices across the nation. The Banker magazine consistently praised Minsheng's development, ranking it number 310 in its top 1,000 business banks in the world in 2004, number 287 in 2005, and number 247 in 2006. In early March 2008, Minsheng obtained the green light from the China Banking Regulatory Commission to buy a 4.9% stake in US-based banking holding company, UCBH Holdings, Inc. ("UCBH") for US$95.7 million. The deal would eventually take Minsheng's stake in UCBH to 9.9%, totalling around US$200 million. The acquisition not only distinguished Minsheng as the first Chinese mainland institution to invest in a US bank, but was also viewed as a milestone for Chinese banks entering the US and international markets. On the flip side, UCBH would soon use this opportunity to make its own moves into China, leveraging its affiliation with Minsheng to totalingacquire other Chinese banks. This case examines the process of international expansion through acquisitions in the banking industry and the positioning of a growing bank in the global market, covering issues such as value creation, impact of government regulation and international barriers, the Chinese banking industry and its development, and the associated risks.

Case Authors : Ricky Lai, Gerald Yong Gao, Jiangyong Lu, Hung Gay Fung

Topic : Global Business

Related Areas : Growth strategy, International business, Mergers & acquisitions, Risk management

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Calculating Net Present Value (NPV) at 6% for Minsheng Bank: Penetrating The US Market Through Acquisition Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10009801)	-10009801	-	-
Year 1	3449084	-6560717	3449084	0.9434	3253853
Year 2	3968593	-2592124	7417677	0.89	3532034
Year 3	3948656	1356532	11366333	0.8396	3315368
Year 4	3244797	4601329	14611130	0.7921	2570183
TOTAL			14611130		12671437

The Net Present Value at 6% discount rate is 2661636

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. Timing of the expected cash flows – stockholders of Minsheng Ucbh 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. Minsheng Ucbh 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 Minsheng Bank: Penetrating The US Market Through Acquisition

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 Global Business 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 Minsheng Ucbh 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 Minsheng Ucbh 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	(10009801)	-10009801	-	-
Year 1	3449084	-6560717	3449084	0.8696	2999203
Year 2	3968593	-2592124	7417677	0.7561	3000826
Year 3	3948656	1356532	11366333	0.6575	2596305
Year 4	3244797	4601329	14611130	0.5718	1855223
TOTAL					10451559

The Net NPV after 4 years is 441758

(10451559 - 10009801 )

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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	(10009801)	-10009801	-	-
Year 1	3449084	-6560717	3449084	0.8333	2874237
Year 2	3968593	-2592124	7417677	0.6944	2755967
Year 3	3948656	1356532	11366333	0.5787	2285102
Year 4	3244797	4601329	14611130	0.4823	1564813
TOTAL					9480119

The Net NPV after 4 years is -529682

At 20% discount rate the NPV is negative (9480119 - 10009801 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Minsheng Ucbh 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 Minsheng Ucbh has a NPV value higher than Zero then finance managers at Minsheng Ucbh 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 Minsheng Ucbh, then the stock price of the Minsheng Ucbh 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 Minsheng Ucbh 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 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.

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 Minsheng Bank: Penetrating The US Market Through Acquisition

References & Further Readings

Ricky Lai, Gerald Yong Gao, Jiangyong Lu, Hung Gay Fung (2018), "Minsheng Bank: Penetrating The US Market Through Acquisition Harvard Business Review Case Study. Published by HBR Publications.