HSBC Holdings PLC - Building a Global Wholesale Banking Capability 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 HSBC Holdings PLC - Building a Global Wholesale Banking Capability case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. HSBC Holdings PLC - Building a Global Wholesale Banking Capability case study is a Harvard Business School (HBR) case study written by Anthony O'Connor, Ingo Walter, Milstein Seymour. The HSBC Holdings PLC - Building a Global Wholesale Banking Capability (referred as “Hsbc Wholesale” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, .

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 HSBC Holdings PLC - Building a Global Wholesale Banking Capability Case Study

This case deals with efforts by HSBC, one of the two largest banks in the world by market capitalization, to develop a wholesale banking franchise that can effectively challenge those of major universal bank competitors such as Citigroup, as well as dominant "monoline" firms such as Goldman Sachs and Morgan Stanley. It highlights the key dimensions of wholesale financial intermediation: loan syndication and project finance, loan securitization and credit default swaps, equity capital markets, debt capital markets, secondary market trading and other investment banking services for clients, as well as principal trading and positioning. Like most players in this market, HSBC had some notable successes and failures, but on the whole did not succeed in breaking into the top ranks of global investment banks despite clearly having the resources to do so. By understanding what it takes to succeed, students should learn a great deal about the competitive dynamics of this industry.

Case Authors : Anthony O'Connor, Ingo Walter, Milstein Seymour

Topic : Finance & Accounting

Related Areas :

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Calculating Net Present Value (NPV) at 6% for HSBC Holdings PLC - Building a Global Wholesale Banking Capability Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10004002)	-10004002	-	-
Year 1	3449620	-6554382	3449620	0.9434	3254358
Year 2	3975686	-2578696	7425306	0.89	3538346
Year 3	3949600	1370904	11374906	0.8396	3316160
Year 4	3221905	4592809	14596811	0.7921	2552051
TOTAL			14596811		12660916

The Net Present Value at 6% discount rate is 2656914

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. Payback Period
2. Net Present Value
3. Internal Rate of Return
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 Hsbc Wholesale 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. Hsbc Wholesale 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 HSBC Holdings PLC - Building a Global Wholesale Banking Capability

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 Hsbc Wholesale 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 Hsbc Wholesale 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	(10004002)	-10004002	-	-
Year 1	3449620	-6554382	3449620	0.8696	2999670
Year 2	3975686	-2578696	7425306	0.7561	3006190
Year 3	3949600	1370904	11374906	0.6575	2596926
Year 4	3221905	4592809	14596811	0.5718	1842135
TOTAL					10444920

The Net NPV after 4 years is 440918

(10444920 - 10004002 )

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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	(10004002)	-10004002	-	-
Year 1	3449620	-6554382	3449620	0.8333	2874683
Year 2	3975686	-2578696	7425306	0.6944	2760893
Year 3	3949600	1370904	11374906	0.5787	2285648
Year 4	3221905	4592809	14596811	0.4823	1553774
TOTAL					9474998

The Net NPV after 4 years is -529004

At 20% discount rate the NPV is negative (9474998 - 10004002 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Hsbc Wholesale 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 Hsbc Wholesale has a NPV value higher than Zero then finance managers at Hsbc Wholesale 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 Hsbc Wholesale, then the stock price of the Hsbc Wholesale 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 Hsbc Wholesale 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 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.

What will be a multi year spillover effect of various taxation regulations.

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 HSBC Holdings PLC - Building a Global Wholesale Banking Capability

References & Further Readings

Anthony O'Connor, Ingo Walter, Milstein Seymour (2018), "HSBC Holdings PLC - Building a Global Wholesale Banking Capability Harvard Business Review Case Study. Published by HBR Publications.