Family Business Succession in Asia 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 Family Business Succession in Asia case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Family Business Succession in Asia case study is a Harvard Business School (HBR) case study written by Marleen Dieleman, Jonathan Ho Wye Kit. The Family Business Succession in Asia (referred as “Wang Charles” 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, Leadership, Organizational culture, Strategy.

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 Family Business Succession in Asia Case Study

The Wang Group was created by Alfred Wang in Hong Kong after fleeing China during the turbulence that marked the beginning of the communist regime. After successfully building up the diversified trading business and expanding to various other Asian countries, in 1995, the business was taken over by his second son, Charles Wang, a charismatic leader. Charles wished to create a more sustainable family business, tuned in to today's global trends, and run by non-family members. To this end, Charles hired an outside CEO to implement his vision after implementing a far-reaching corporate change program. The global economic crisis that started in 2008, however, caught the company halfway through the reorganization, and brought losses and the departure of the newly hired CEO. Charles Wang had no other option than to again take up the top job himself, and had to reconsider the path towards a sustainable future for the family firm.

Case Authors : Marleen Dieleman, Jonathan Ho Wye Kit

Topic : Leadership & Managing People

Related Areas : Leadership, Organizational culture, Strategy

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Calculating Net Present Value (NPV) at 6% for Family Business Succession in Asia Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10016815)	-10016815	-	-
Year 1	3471768	-6545047	3471768	0.9434	3275253
Year 2	3978531	-2566516	7450299	0.89	3540878
Year 3	3946391	1379875	11396690	0.8396	3313466
Year 4	3225832	4605707	14622522	0.7921	2555161
TOTAL			14622522		12684758

The Net Present Value at 6% discount rate is 2667943

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. Wang Charles 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 Wang Charles 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 Family Business Succession in Asia

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 Wang Charles 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 Wang Charles 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	(10016815)	-10016815	-	-
Year 1	3471768	-6545047	3471768	0.8696	3018929
Year 2	3978531	-2566516	7450299	0.7561	3008341
Year 3	3946391	1379875	11396690	0.6575	2594816
Year 4	3225832	4605707	14622522	0.5718	1844380
TOTAL					10466466

The Net NPV after 4 years is 449651

(10466466 - 10016815 )

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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	(10016815)	-10016815	-	-
Year 1	3471768	-6545047	3471768	0.8333	2893140
Year 2	3978531	-2566516	7450299	0.6944	2762869
Year 3	3946391	1379875	11396690	0.5787	2283791
Year 4	3225832	4605707	14622522	0.4823	1555667
TOTAL					9495467

The Net NPV after 4 years is -521348

At 20% discount rate the NPV is negative (9495467 - 10016815 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Wang Charles 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 Wang Charles has a NPV value higher than Zero then finance managers at Wang Charles 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 Wang Charles, then the stock price of the Wang Charles 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 Wang Charles 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 will be a multi year spillover effect of various taxation regulations.

What can impact the cash flow of the project.

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 Family Business Succession in Asia

References & Further Readings

Marleen Dieleman, Jonathan Ho Wye Kit (2018), "Family Business Succession in Asia Harvard Business Review Case Study. Published by HBR Publications.