Highbridge Capital Management: Building a Sustainable Organization 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 Highbridge Capital Management: Building a Sustainable Organization case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Highbridge Capital Management: Building a Sustainable Organization case study is a Harvard Business School (HBR) case study written by Roderick M. Kramer, Michael Brimm, Victoria Chang, Julia Bator. The Highbridge Capital Management: Building a Sustainable Organization (referred as “Highbridge Dubin” from here on) case study provides evaluation & decision scenario in field of Leadership & Managing People. It also touches upon business topics such as - Value proposition, Entrepreneurial finance, Financial management, Leadership, Mergers & acquisitions, Organizational structure, Succession planning, Talent 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 Highbridge Capital Management: Building a Sustainable Organization Case Study

In 2010 Glenn Dubin reflected upon the enduring organization and culture he and co-founder Henry Swieca had infused into Highbridge Capital Management over the course of almost two decades. Since the firm's launch in 1992, New York-based Highbridge had grown to become a diversified investment platform comprising hedge funds, traditional asset management products, and credit and equity investments with longer-term holding periods. The company employed more than 315 people at offices in New York, London, Hong Kong and Tokyo, and managed $21 billion for prominent institutional investors, public and corporate pension funds, endowments, foundations and family offices. Highbridge was known by many on Wall Street as a "benchmark," largely due to the firm's investment performance and to the diversity and dynamism of the organization. Investors had come to rely on Highbridge's consistent returns and attention to risk management. The firm comprised a group of gifted, committed professionals as a result of Dubin's longtime focus on talent, nurturing a culture of collaboration, building a sophisticated risk management and technology platform, and maintaining a robust operating infrastructure. In 2009, J.P. Morgan completed its purchase of Highbridge-a strategic partnership the two organizations began in 2004 when J.P. Morgan Asset Management purchased a majority interest in the firm. In 2010, Dubin described his desired impact on the increasingly complex and sophisticated organization: "I hope that my legacy will be a bigger and more diversified Highbridge-but one that has the same culture and core principles of excellence, staffed with individuals with high integrity and an interest in successful collaboration. This is the only way I know to ensure that our initial goal of creating an organization that can outlive its founders will be achieved."

Case Authors : Roderick M. Kramer, Michael Brimm, Victoria Chang, Julia Bator

Topic : Leadership & Managing People

Related Areas : Entrepreneurial finance, Financial management, Leadership, Mergers & acquisitions, Organizational structure, Succession planning, Talent management

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Calculating Net Present Value (NPV) at 6% for Highbridge Capital Management: Building a Sustainable Organization Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10023997)	-10023997	-	-
Year 1	3466615	-6557382	3466615	0.9434	3270392
Year 2	3979092	-2578290	7445707	0.89	3541378
Year 3	3975827	1397537	11421534	0.8396	3338181
Year 4	3224120	4621657	14645654	0.7921	2553805
TOTAL			14645654		12703755

The Net Present Value at 6% discount rate is 2679758

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. Internal Rate of Return
3. Payback Period
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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Highbridge Dubin 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 Highbridge Dubin 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 Highbridge Capital Management: Building a Sustainable Organization

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 Leadership & Managing People 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 Highbridge Dubin 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 Highbridge Dubin 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	(10023997)	-10023997	-	-
Year 1	3466615	-6557382	3466615	0.8696	3014448
Year 2	3979092	-2578290	7445707	0.7561	3008765
Year 3	3975827	1397537	11421534	0.6575	2614171
Year 4	3224120	4621657	14645654	0.5718	1843401
TOTAL					10480785

The Net NPV after 4 years is 456788

(10480785 - 10023997 )

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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	(10023997)	-10023997	-	-
Year 1	3466615	-6557382	3466615	0.8333	2888846
Year 2	3979092	-2578290	7445707	0.6944	2763258
Year 3	3975827	1397537	11421534	0.5787	2300826
Year 4	3224120	4621657	14645654	0.4823	1554842
TOTAL					9507772

The Net NPV after 4 years is -516225

At 20% discount rate the NPV is negative (9507772 - 10023997 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Highbridge Dubin 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 Highbridge Dubin has a NPV value higher than Zero then finance managers at Highbridge Dubin 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 Highbridge Dubin, then the stock price of the Highbridge Dubin 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 Highbridge Dubin 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.

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 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 Highbridge Capital Management: Building a Sustainable Organization

References & Further Readings

Roderick M. Kramer, Michael Brimm, Victoria Chang, Julia Bator (2018), "Highbridge Capital Management: Building a Sustainable Organization Harvard Business Review Case Study. Published by HBR Publications.