Victory Bank Limited (A) 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 Victory Bank Limited (A) case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Victory Bank Limited (A) case study is a Harvard Business School (HBR) case study written by W. Glenn Rowe, Uhnat Kohli. The Victory Bank Limited (A) (referred as “Victory Vice” 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, Government, Managing up.

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 Victory Bank Limited (A) Case Study

The vice-president of corporate and institutional banking at Victory Bank Limited (VBL) finds himself in a political imbroglio. He needs to respond to the request by VBL's head of retail and private banking to join his team, even though the vice-president shares an excellent relationship with his current boss and is a star performer within the organization. The vice-president needs to decide his next steps: whether to accept that new role or to decline it. Students will come to understand how they can get caught in political battles and how best to manage the politics within the organization. Students will also learn to think their way through the various options faced when tackling similar situations.

Case Authors : W. Glenn Rowe, Uhnat Kohli

Topic : Leadership & Managing People

Related Areas : Government, Managing up

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Calculating Net Present Value (NPV) at 6% for Victory Bank Limited (A) Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10017549)	-10017549	-	-
Year 1	3461617	-6555932	3461617	0.9434	3265676
Year 2	3961748	-2594184	7423365	0.89	3525942
Year 3	3936288	1342104	11359653	0.8396	3304983
Year 4	3250322	4592426	14609975	0.7921	2574559
TOTAL			14609975		12671161

The Net Present Value at 6% discount rate is 2653612

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. Internal Rate of Return
2. Payback Period
3. Profitability Index
4. Net Present Value

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. Victory Vice 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 Victory Vice 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 Victory Bank Limited (A)

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 Victory Vice 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 Victory Vice 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	(10017549)	-10017549	-	-
Year 1	3461617	-6555932	3461617	0.8696	3010102
Year 2	3961748	-2594184	7423365	0.7561	2995651
Year 3	3936288	1342104	11359653	0.6575	2588173
Year 4	3250322	4592426	14609975	0.5718	1858382
TOTAL					10452308

The Net NPV after 4 years is 434759

(10452308 - 10017549 )

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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	(10017549)	-10017549	-	-
Year 1	3461617	-6555932	3461617	0.8333	2884681
Year 2	3961748	-2594184	7423365	0.6944	2751214
Year 3	3936288	1342104	11359653	0.5787	2277944
Year 4	3250322	4592426	14609975	0.4823	1567478
TOTAL					9481317

The Net NPV after 4 years is -536232

At 20% discount rate the NPV is negative (9481317 - 10017549 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Victory Vice 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 Victory Vice has a NPV value higher than Zero then finance managers at Victory Vice 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 Victory Vice, then the stock price of the Victory Vice 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 Victory Vice 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.

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

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 Victory Bank Limited (A)

References & Further Readings

W. Glenn Rowe, Uhnat Kohli (2018), "Victory Bank Limited (A) Harvard Business Review Case Study. Published by HBR Publications.