Against the Big Four: Growth Strategies for Indigenous Chinese CPA Firms 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 Against the Big Four: Growth Strategies for Indigenous Chinese CPA Firms case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Against the Big Four: Growth Strategies for Indigenous Chinese CPA Firms case study is a Harvard Business School (HBR) case study written by Christine Chan, Josephine Lau. The Against the Big Four: Growth Strategies for Indigenous Chinese CPA Firms (referred as “Cpa Shinewing” from here on) case study provides evaluation & decision scenario in field of Global Business. It also touches upon business topics such as - Value proposition, Globalization, Government, Growth strategy, Mergers & acquisitions.

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 Against the Big Four: Growth Strategies for Indigenous Chinese CPA Firms Case Study

The merger between China's ShineWing Certified Public Accountants and Hong Kong firm Ho and Ho & Company came at a time when most indigenous Chinese CPA practices had fled independence by either merging with one of the four global firms dominating the industry or joining international networks in order to address the increasing globalization of China's capital market. Between 2002 and 2006, China's CPA market more than doubled in revenue size, and the share captured by the big four grew from 37% to 53%. The founder of ShineWing was optimistic that, under the current outlook, China presented the right economic conditions to nurture its own global brand of CPA firm. If he was right, what remained to be defined was a strategy to achieve it. Would offshore mergers prove a viable strategy for China's homegrown CPA firms to expand globally, or would a pan-Chinese network with the right critical mass be the answer? What would be the value proposition of an indigenous CPA firm to Chinese enterprises, other than political considerations? What would be the challenges for a Chinese CPA brand if it were to go global? How could it integrate offshore operations so that it could effectively deliver its brand promise to its clients?

Case Authors : Christine Chan, Josephine Lau

Topic : Global Business

Related Areas : Globalization, Government, Growth strategy, Mergers & acquisitions

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Calculating Net Present Value (NPV) at 6% for Against the Big Four: Growth Strategies for Indigenous Chinese CPA Firms Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10021783)	-10021783	-	-
Year 1	3448376	-6573407	3448376	0.9434	3253185
Year 2	3975851	-2597556	7424227	0.89	3538493
Year 3	3963565	1366009	11387792	0.8396	3327886
Year 4	3241194	4607203	14628986	0.7921	2567329
TOTAL			14628986		12686893

The Net Present Value at 6% discount rate is 2665110

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. Profitability Index
2. Payback Period
3. Net Present Value
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Cpa Shinewing 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 Cpa Shinewing 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 Against the Big Four: Growth Strategies for Indigenous Chinese CPA Firms

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 Cpa Shinewing 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 Cpa Shinewing 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	(10021783)	-10021783	-	-
Year 1	3448376	-6573407	3448376	0.8696	2998588
Year 2	3975851	-2597556	7424227	0.7561	3006315
Year 3	3963565	1366009	11387792	0.6575	2606108
Year 4	3241194	4607203	14628986	0.5718	1853163
TOTAL					10464174

The Net NPV after 4 years is 442391

(10464174 - 10021783 )

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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	(10021783)	-10021783	-	-
Year 1	3448376	-6573407	3448376	0.8333	2873647
Year 2	3975851	-2597556	7424227	0.6944	2761008
Year 3	3963565	1366009	11387792	0.5787	2293730
Year 4	3241194	4607203	14628986	0.4823	1563076
TOTAL					9491460

The Net NPV after 4 years is -530323

At 20% discount rate the NPV is negative (9491460 - 10021783 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Cpa Shinewing 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 Cpa Shinewing has a NPV value higher than Zero then finance managers at Cpa Shinewing 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 Cpa Shinewing, then the stock price of the Cpa Shinewing 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 Cpa Shinewing 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 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.

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.

Understanding of risks involved in the project.

What can impact the cash flow of 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 Against the Big Four: Growth Strategies for Indigenous Chinese CPA Firms

References & Further Readings

Christine Chan, Josephine Lau (2018), "Against the Big Four: Growth Strategies for Indigenous Chinese CPA Firms Harvard Business Review Case Study. Published by HBR Publications.