Scandal at Societe Generale: Rogue Trader or Willing Accomplice? 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 Scandal at Societe Generale: Rogue Trader or Willing Accomplice? case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Scandal at Societe Generale: Rogue Trader or Willing Accomplice? case study is a Harvard Business School (HBR) case study written by Russell Walker. The Scandal at Societe Generale: Rogue Trader or Willing Accomplice? (referred as “Trader Kerviel's” 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, Decision making, Public relations, Risk 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 Scandal at Societe Generale: Rogue Trader or Willing Accomplice? Case Study

This case covers the scandal that occurred in 2008 at SociA?tA? GA?nA?rale when one trader, JA?rA?me Kerviel, lost the prominent French bank nearly a??5 billion through his unauthorized trading. The case describes Kerviel's schemes as well as SocGen's internal monitoring and reporting processes, organizational structures, and culture so that students reading the case can identify and discuss the shortcomings of the firm's risk management practices. The case and epilogue also describe the French government's and Finance Minister Christine Lagarde's reactions to the scandal (e.g., imposition of a a??4 million fine and increased regulations), prompting students to consider the role of government in overseeing that healthy risk management practices are followed in key industries (such as banking) that are highly entwined with entire economies. Finally, the case encourages students-during class discussion-to critically consider whether it is truly possible for one rogue trader to act alone, which elements in a work environment enable or even encourage risky behavior, and who should be held accountable when such scandals occur. Interestingly, this case highlights a story that is not unique. Prior to Kerviel's transgressions were the similar scandals of Nick Leeson at Barings Bank and Toshihide Iguchi at Daiwa Bank, yet history has repeated itself. This case gives students a vivid example of the dangers of internal, self-inflicted risk on organizations, and it opens a discussion on how to avoid it.

Case Authors : Russell Walker

Topic : Leadership & Managing People

Related Areas : Decision making, Public relations, Risk management

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Calculating Net Present Value (NPV) at 6% for Scandal at Societe Generale: Rogue Trader or Willing Accomplice? Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10022394)	-10022394	-	-
Year 1	3463962	-6558432	3463962	0.9434	3267889
Year 2	3965198	-2593234	7429160	0.89	3529012
Year 3	3966726	1373492	11395886	0.8396	3330540
Year 4	3234651	4608143	14630537	0.7921	2562147
TOTAL			14630537		12689587

The Net Present Value at 6% discount rate is 2667193

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. Payback Period
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. Trader Kerviel's 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 Trader Kerviel's 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 Scandal at Societe Generale: Rogue Trader or Willing Accomplice?

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 Trader Kerviel's 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 Trader Kerviel's 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	(10022394)	-10022394	-	-
Year 1	3463962	-6558432	3463962	0.8696	3012141
Year 2	3965198	-2593234	7429160	0.7561	2998259
Year 3	3966726	1373492	11395886	0.6575	2608187
Year 4	3234651	4608143	14630537	0.5718	1849422
TOTAL					10468009

The Net NPV after 4 years is 445615

(10468009 - 10022394 )

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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	(10022394)	-10022394	-	-
Year 1	3463962	-6558432	3463962	0.8333	2886635
Year 2	3965198	-2593234	7429160	0.6944	2753610
Year 3	3966726	1373492	11395886	0.5787	2295559
Year 4	3234651	4608143	14630537	0.4823	1559920
TOTAL					9495724

The Net NPV after 4 years is -526670

At 20% discount rate the NPV is negative (9495724 - 10022394 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Trader Kerviel's 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 Trader Kerviel's has a NPV value higher than Zero then finance managers at Trader Kerviel's 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 Trader Kerviel's, then the stock price of the Trader Kerviel's 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 Trader Kerviel's 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.

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 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 Scandal at Societe Generale: Rogue Trader or Willing Accomplice?

References & Further Readings

Russell Walker (2018), "Scandal at Societe Generale: Rogue Trader or Willing Accomplice? Harvard Business Review Case Study. Published by HBR Publications.