American Express TRS Charge-Card Receivables, Spanish Version 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 American Express TRS Charge-Card Receivables, Spanish Version case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. American Express TRS Charge-Card Receivables, Spanish Version case study is a Harvard Business School (HBR) case study written by Andre F. Perold, Kuljot Singh. The American Express TRS Charge-Card Receivables, Spanish Version (referred as “Trs Securitization” 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 management, Reorganization.

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 American Express TRS Charge-Card Receivables, Spanish Version Case Study

American Express (TRS) Co. is considering a proposal to securitize a portion of their consumer charge-card receivables portfolio. In the past, they have relied exclusively on a captive finance subsidiary, Credco, to perform this function. The proposed securitization structure has been put forth by Lehman Brothers and relies heavily on the existing structure of credit-card receivables' securitizations. The growing asset-backed securities market presents TRS an opportunity to diversify its sources of funds--however, there are reasons to be cautious. Due to recent downgrades of American Express and Credco debt, the perceived financial weakness of credit-card receivable backed securities issuers, and the proposal's sophisticated securitization structure, TRS is concerned that 1) The market may perceive securitization as a sign of weakness; 2) The securitization may not be cost effective. Therefore, TRS has to decide whether or not to proceed with securitization at this time.

Case Authors : Andre F. Perold, Kuljot Singh

Topic : Finance & Accounting

Related Areas : Financial management, Reorganization

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Calculating Net Present Value (NPV) at 6% for American Express TRS Charge-Card Receivables, Spanish Version Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10028028)	-10028028	-	-
Year 1	3469443	-6558585	3469443	0.9434	3273059
Year 2	3969711	-2588874	7439154	0.89	3533029
Year 3	3948287	1359413	11387441	0.8396	3315058
Year 4	3243095	4602508	14630536	0.7921	2568835
TOTAL			14630536		12689981

The Net Present Value at 6% discount rate is 2661953

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. Net Present Value
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Trs Securitization 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 Trs Securitization 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 American Express TRS Charge-Card Receivables, Spanish Version

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 Trs Securitization 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 Trs Securitization 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	(10028028)	-10028028	-	-
Year 1	3469443	-6558585	3469443	0.8696	3016907
Year 2	3969711	-2588874	7439154	0.7561	3001672
Year 3	3948287	1359413	11387441	0.6575	2596063
Year 4	3243095	4602508	14630536	0.5718	1854250
TOTAL					10468892

The Net NPV after 4 years is 440864

(10468892 - 10028028 )

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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	(10028028)	-10028028	-	-
Year 1	3469443	-6558585	3469443	0.8333	2891203
Year 2	3969711	-2588874	7439154	0.6944	2756744
Year 3	3948287	1359413	11387441	0.5787	2284888
Year 4	3243095	4602508	14630536	0.4823	1563993
TOTAL					9496827

The Net NPV after 4 years is -531201

At 20% discount rate the NPV is negative (9496827 - 10028028 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Trs Securitization 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 Trs Securitization has a NPV value higher than Zero then finance managers at Trs Securitization 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 Trs Securitization, then the stock price of the Trs Securitization 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 Trs Securitization 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.

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 can impact the cash flow of 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 American Express TRS Charge-Card Receivables, Spanish Version

References & Further Readings

Andre F. Perold, Kuljot Singh (2018), "American Express TRS Charge-Card Receivables, Spanish Version Harvard Business Review Case Study. Published by HBR Publications.