Dow's Acquisition Program 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 Dow's Acquisition Program case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Dow's Acquisition Program case study is a Harvard Business School (HBR) case study written by Koen H. Heimericks, Stephen Gates. The Dow's Acquisition Program (referred as “Dow's Integration” 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, .

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 Dow's Acquisition Program Case Study

This case illustrates how Dow Chemical acquired and integrated Wolff Walsrode, a German specialty chemicals firm that was part of the Bayer Group. This acquisition, combined with Dow's existing cellulosics unit, helped it create a new specialty business with a forecasted $1.1 billion in annual sales and strengthen its footprint in Central and Eastern Europe. The main challenge in this case concerns the complexities of acquisition integration, which are demanding in spite of Dow's extensive experience and track record. Dow is confronted with various integration challenges and faces several decisions concerning the degree and speed of integration of Wolff Walsrode and one of its units, Probis. The decisions pit considerations of rapid cost synergy capture via leveraging global systems platforms against process technology transfer and accommodating different customers and their requirements. Along with providing a review of the importance of a multitude of codified implementation templates and tacit integration mechanisms, this case illustrates how Dow's M&A integration personnel prove their worth by ensuring Wolff's successful integration. The case confronts students with the complexities and uncertainties of cross-border acquisition integration (e.g. speed, level of integration) and the way in which a renowned serial acquirer like Dow manages a medium-sized integration. Moreover, it presents the inherent complexities involved in decision-making in the context of acquisition programs. Lastly, it underlines the pros and cons of mergers and acquisition (M&A) experience, how to appropriately use M&A experience, and the role deliberate learning mechanisms contained in Dow's M&A methodology (the M&A Technology Center) play in improving the success rate of integrating acquisitions.

Case Authors : Koen H. Heimericks, Stephen Gates

Topic : Leadership & Managing People

Related Areas :

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Calculating Net Present Value (NPV) at 6% for Dow's Acquisition Program Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10013862)	-10013862	-	-
Year 1	3462679	-6551183	3462679	0.9434	3266678
Year 2	3966078	-2585105	7428757	0.89	3529795
Year 3	3939904	1354799	11368661	0.8396	3308019
Year 4	3241415	4596214	14610076	0.7921	2567504
TOTAL			14610076		12671997

The Net Present Value at 6% discount rate is 2658135

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. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Dow's Integration 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 Dow's Integration 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 Dow's Acquisition Program

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 Dow's Integration 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 Dow's Integration 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	(10013862)	-10013862	-	-
Year 1	3462679	-6551183	3462679	0.8696	3011025
Year 2	3966078	-2585105	7428757	0.7561	2998925
Year 3	3939904	1354799	11368661	0.6575	2590551
Year 4	3241415	4596214	14610076	0.5718	1853290
TOTAL					10453790

The Net NPV after 4 years is 439928

(10453790 - 10013862 )

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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	(10013862)	-10013862	-	-
Year 1	3462679	-6551183	3462679	0.8333	2885566
Year 2	3966078	-2585105	7428757	0.6944	2754221
Year 3	3939904	1354799	11368661	0.5787	2280037
Year 4	3241415	4596214	14610076	0.4823	1563182
TOTAL					9483006

The Net NPV after 4 years is -530856

At 20% discount rate the NPV is negative (9483006 - 10013862 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Dow's Integration 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 Dow's Integration has a NPV value higher than Zero then finance managers at Dow's Integration 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 Dow's Integration, then the stock price of the Dow's Integration 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 Dow's Integration 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 are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

Understanding of risks involved in the project.

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

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 Dow's Acquisition Program

References & Further Readings

Koen H. Heimericks, Stephen Gates (2018), "Dow's Acquisition Program Harvard Business Review Case Study. Published by HBR Publications.