FINANCIAL PIONEERING: THE GENENTECH ACQUISITION BY ROCHE 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 FINANCIAL PIONEERING: THE GENENTECH ACQUISITION BY ROCHE case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. FINANCIAL PIONEERING: THE GENENTECH ACQUISITION BY ROCHE case study is a Harvard Business School (HBR) case study written by Stewart Hamilton, Anna Eckardt Salvatore. The FINANCIAL PIONEERING: THE GENENTECH ACQUISITION BY ROCHE (referred as “Roche Bonds” 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, Financial management, Leadership.

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 FINANCIAL PIONEERING: THE GENENTECH ACQUISITION BY ROCHE Case Study

The case describes the financing of the Genentech acquisition by Roche. The case explores the innovative way of financing by Roche at the beginning of 2009, just months after the Lehman Brothers bankruptcy. With equity markets in free fall, and with debt markets "shut off", the CFO of Roche manages to finance an acquisition costing more than USD 40 billion, and scores three hits in a matter of weeks: a) the largest private issue of bonds in the US (USD 16.6 billion); b) the largest private issue of bonds in Continental Europe (Euro 11.25 billion); c) the largest private issue of bonds in UK (Sterling1.25 billion). The case presents the facts, the issues at stake, and the incredibly bold and innovative financiang route chosen by the Roche CFO. Learning objectives: The main teaching point of this case is its "anti-crisis" message. At one of the worst possible moments of the 2008 financial crisis, an enlightened CFO (with a small team of talented people) decides that he cannot be affected by the external environment, and decides to go ahead to finance a value creating investment opportunity. The main learnings from this case are: 1) making class participants realize that there are alternative ways to finance good investment opportunities; 2) that although capital structure is important, the creating value mechanism was the project rather than financing; 3) that the financing, however, was the enabler of the value creation potential of the project.

Case Authors : Stewart Hamilton, Anna Eckardt Salvatore

Topic : Leadership & Managing People

Related Areas : Financial management, Leadership

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Calculating Net Present Value (NPV) at 6% for FINANCIAL PIONEERING: THE GENENTECH ACQUISITION BY ROCHE Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10004901)	-10004901	-	-
Year 1	3466557	-6538344	3466557	0.9434	3270337
Year 2	3962079	-2576265	7428636	0.89	3526236
Year 3	3974199	1397934	11402835	0.8396	3336814
Year 4	3246712	4644646	14649547	0.7921	2571700
TOTAL			14649547		12705087

The Net Present Value at 6% discount rate is 2700186

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. Net Present Value
2. Profitability Index
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. Roche Bonds 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 Roche Bonds 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 FINANCIAL PIONEERING: THE GENENTECH ACQUISITION BY ROCHE

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 Roche Bonds 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 Roche Bonds 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	(10004901)	-10004901	-	-
Year 1	3466557	-6538344	3466557	0.8696	3014397
Year 2	3962079	-2576265	7428636	0.7561	2995901
Year 3	3974199	1397934	11402835	0.6575	2613100
Year 4	3246712	4644646	14649547	0.5718	1856318
TOTAL					10479717

The Net NPV after 4 years is 474816

(10479717 - 10004901 )

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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	(10004901)	-10004901	-	-
Year 1	3466557	-6538344	3466557	0.8333	2888798
Year 2	3962079	-2576265	7428636	0.6944	2751444
Year 3	3974199	1397934	11402835	0.5787	2299884
Year 4	3246712	4644646	14649547	0.4823	1565737
TOTAL					9505862

The Net NPV after 4 years is -499039

At 20% discount rate the NPV is negative (9505862 - 10004901 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Roche Bonds 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 Roche Bonds has a NPV value higher than Zero then finance managers at Roche Bonds 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 Roche Bonds, then the stock price of the Roche Bonds 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 Roche Bonds 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 –

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.

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 FINANCIAL PIONEERING: THE GENENTECH ACQUISITION BY ROCHE

References & Further Readings

Stewart Hamilton, Anna Eckardt Salvatore (2018), "FINANCIAL PIONEERING: THE GENENTECH ACQUISITION BY ROCHE Harvard Business Review Case Study. Published by HBR Publications.