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Blackstone Alternative Asset Management 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 Blackstone Alternative Asset Management case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Blackstone Alternative Asset Management case study is a Harvard Business School (HBR) case study written by Robin Greenwood, Luis M. Viceira, Jared Dourdeville. The Blackstone Alternative Asset Management (referred as “Blackstone Baam” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Business models, Financial management, Growth strategy.

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 Blackstone Alternative Asset Management Case Study


This case explores reasons for Blackstone Alternative Asset Management's (BAAM's) growth from 2007-2013, a time when the overall fund of hedge funds industry contracted substantially. Additionally, the case analyzes evolving business models and value propositions within the fund of hedge funds industry. J. Tomilson Hill, CEO of BAAM and Vice-Chairman of The Blackstone Group, is the protagonist. At the time of the case, BAAM was considering two potential directions for future growth: 1) providing hedge fund products for the defined contribution pension space, and 2) beginning direct internal "manufacturing" of investments. In the context of the current fund of hedge funds industry, the case considers challenges and opportunities for these potential new areas for growth.


Case Authors : Robin Greenwood, Luis M. Viceira, Jared Dourdeville

Topic : Finance & Accounting

Related Areas : Business models, Financial management, Growth strategy




Calculating Net Present Value (NPV) at 6% for Blackstone Alternative Asset Management Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10027825) -10027825 - -
Year 1 3461388 -6566437 3461388 0.9434 3265460
Year 2 3962872 -2603565 7424260 0.89 3526942
Year 3 3967193 1363628 11391453 0.8396 3330932
Year 4 3225042 4588670 14616495 0.7921 2554535
TOTAL 14616495 12677869




The Net Present Value at 6% discount rate is 2650044

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. Profitability Index
2. Payback Period
3. Internal Rate of Return
4. Net Present Value

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 Blackstone Baam 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. Blackstone Baam shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of Blackstone Alternative Asset Management

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 Blackstone Baam 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 Blackstone Baam 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 (10027825) -10027825 - -
Year 1 3461388 -6566437 3461388 0.8696 3009903
Year 2 3962872 -2603565 7424260 0.7561 2996501
Year 3 3967193 1363628 11391453 0.6575 2608494
Year 4 3225042 4588670 14616495 0.5718 1843928
TOTAL 10458825


The Net NPV after 4 years is 431000

(10458825 - 10027825 )








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 (10027825) -10027825 - -
Year 1 3461388 -6566437 3461388 0.8333 2884490
Year 2 3962872 -2603565 7424260 0.6944 2751994
Year 3 3967193 1363628 11391453 0.5787 2295829
Year 4 3225042 4588670 14616495 0.4823 1555286
TOTAL 9487600


The Net NPV after 4 years is -540225

At 20% discount rate the NPV is negative (9487600 - 10027825 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Blackstone Baam 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 Blackstone Baam has a NPV value higher than Zero then finance managers at Blackstone Baam 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 Blackstone Baam, then the stock price of the Blackstone Baam 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 Blackstone Baam 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 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.

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.

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 Blackstone Alternative Asset Management

References & Further Readings

Robin Greenwood, Luis M. Viceira, Jared Dourdeville (2018), "Blackstone Alternative Asset Management Harvard Business Review Case Study. Published by HBR Publications.


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