Cultural Challenges of Integration: Value Creation and Daiichi Sankyo's Indian Acquisition 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 Cultural Challenges of Integration: Value Creation and Daiichi Sankyo's Indian Acquisition case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Cultural Challenges of Integration: Value Creation and Daiichi Sankyo's Indian Acquisition case study is a Harvard Business School (HBR) case study written by Beng Geok Wee, Wilfred Chua. The Cultural Challenges of Integration: Value Creation and Daiichi Sankyo's Indian Acquisition (referred as “Ranbaxy Daiichi” 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, Mergers & acquisitions, Organizational culture.

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 Cultural Challenges of Integration: Value Creation and Daiichi Sankyo's Indian Acquisition Case Study

In the first decade of 2000, major global innovator drug companies were acquiring or collaborating with generic drug companies. Daiichi Sankyo was the first major Japanese Pharmaceutical firm to test this 'hybrid' business model in early 2008 when it acquired a majority share in Ranbaxy, then the largest India-based generic drug company and a global generic drug manufacturer and exporter. At Ranbaxy, the acquisition was followed quickly by several leadership changes. Chairman/ CEO Malvinder Singh, the grandson of Ranbaxy's founder, resigned in May 2009; Atul Sobti who took over as CEO, resigned the following year citing differences with the Japanese company on the running of Ranbaxy. In early 2011, Ranbaxy President and Chief Financial Officer, Omesh Sethi also left the company. On the financial front, the Japanese firm booked a valuation loss of US$3.9 billion from the acquisition in the third quarter of its 2008 financial year and recorded a net loss of US$2.21 billion for that financial year. With the acquisition, Daiichi Sankyo was able to expand the scope of its global business and to lessen the concentration of its assets in Japan from 78.96% to 53.7% in 2011. However, in 2011, the Japanese firm had yet to reap the full benefits of its vision of a value chain based on an integrated hybrid business model. Was a transformational organizational change needed to realize this? The case study examines the cross-cultural challenges of integrating the two businesses as the leadership worked to implement the hybrid business model.

Case Authors : Beng Geok Wee, Wilfred Chua

Topic : Leadership & Managing People

Related Areas : Mergers & acquisitions, Organizational culture

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Calculating Net Present Value (NPV) at 6% for Cultural Challenges of Integration: Value Creation and Daiichi Sankyo's Indian Acquisition Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10012421)	-10012421	-	-
Year 1	3458641	-6553780	3458641	0.9434	3262869
Year 2	3972689	-2581091	7431330	0.89	3535679
Year 3	3950199	1369108	11381529	0.8396	3316663
Year 4	3222113	4591221	14603642	0.7921	2552215
TOTAL			14603642		12667426

The Net Present Value at 6% discount rate is 2655005

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. Ranbaxy Daiichi 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 Ranbaxy Daiichi 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 Cultural Challenges of Integration: Value Creation and Daiichi Sankyo's Indian Acquisition

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 Ranbaxy Daiichi 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 Ranbaxy Daiichi 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	(10012421)	-10012421	-	-
Year 1	3458641	-6553780	3458641	0.8696	3007514
Year 2	3972689	-2581091	7431330	0.7561	3003924
Year 3	3950199	1369108	11381529	0.6575	2597320
Year 4	3222113	4591221	14603642	0.5718	1842254
TOTAL					10451011

The Net NPV after 4 years is 438590

(10451011 - 10012421 )

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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	(10012421)	-10012421	-	-
Year 1	3458641	-6553780	3458641	0.8333	2882201
Year 2	3972689	-2581091	7431330	0.6944	2758812
Year 3	3950199	1369108	11381529	0.5787	2285995
Year 4	3222113	4591221	14603642	0.4823	1553874
TOTAL					9480881

The Net NPV after 4 years is -531540

At 20% discount rate the NPV is negative (9480881 - 10012421 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Ranbaxy Daiichi 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 Ranbaxy Daiichi has a NPV value higher than Zero then finance managers at Ranbaxy Daiichi 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 Ranbaxy Daiichi, then the stock price of the Ranbaxy Daiichi 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 Ranbaxy Daiichi 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.

Understanding of risks involved in the project.

What can impact the cash flow of the project.

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.

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 Cultural Challenges of Integration: Value Creation and Daiichi Sankyo's Indian Acquisition

References & Further Readings

Beng Geok Wee, Wilfred Chua (2018), "Cultural Challenges of Integration: Value Creation and Daiichi Sankyo's Indian Acquisition Harvard Business Review Case Study. Published by HBR Publications.