Mergers and People: Key Factors for an Effective Acquisition and for Surviving One 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 Mergers and People: Key Factors for an Effective Acquisition and for Surviving One case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Mergers and People: Key Factors for an Effective Acquisition and for Surviving One case study is a Harvard Business School (HBR) case study written by Guido Stein Martinez, Marta Cuadrado. The Mergers and People: Key Factors for an Effective Acquisition and for Surviving One (referred as “Mergers Evidence” 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, Mergers & acquisitions, Organizational structure.

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 Mergers and People: Key Factors for an Effective Acquisition and for Surviving One Case Study

The aim of this technical note is to consider the human dimension of mergers and acquisitions and the way these processes impact people. In the substantial body of scientific literature that exists on this topic, authors discuss the rules and "magic" formulas that lead to a successful acquisition, grounding their arguments in empirical evidence. One of the first conclusions that can be drawn from examining this literature is that the authors cite a wide variety of empirical evidence in each case, and that this evidence serves to support different, and even contradictory, theses concerning the key aspects and elements of company acquisitions. Rationalizations are made a posteriori and seek to offer rules, or something close to that. They should be taken as broad approximations, but do point in the right direction. As a result, they are perhaps more useful for those whose work involves taking action than they are for academics concerned with scientific rigor.Acquisitions affect everyone involved to one degree or another. They are not neutral transactions in any sense: not from a financial, tax, legal, operational or commercial perspective, and especially not in terms of how they impact the people in both companies involved and other stakeholders (shareholders, suppliers, customers, etc.).For many companies, mergers by acquisition have become a recurrent strategy for dealing with competition, gaining market share, or simply ensuring their survival. Their impact on stock markets is noted within hours, but their consequences for the people who live though them are rarely reflected in the media.In this technical note we will address a number of issues related to mergers. First, we will look at the key reasons why companies decide to pursue them and the reasons why many fail. Second, we will consider the inevitable realities associated with mergers. We will also discuss human due diligence and devote a section to the importance of merger and integration committees. Finally

Case Authors : Guido Stein Martinez, Marta Cuadrado

Topic : Leadership & Managing People

Related Areas : Leadership, Mergers & acquisitions, Organizational structure

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Calculating Net Present Value (NPV) at 6% for Mergers and People: Key Factors for an Effective Acquisition and for Surviving One Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10007913)	-10007913	-	-
Year 1	3452457	-6555456	3452457	0.9434	3257035
Year 2	3976328	-2579128	7428785	0.89	3538918
Year 3	3962293	1383165	11391078	0.8396	3326818
Year 4	3231859	4615024	14622937	0.7921	2559935
TOTAL			14622937		12682705

The Net Present Value at 6% discount rate is 2674792

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

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. Mergers Evidence 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 Mergers Evidence 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 Mergers and People: Key Factors for an Effective Acquisition and for Surviving One

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 Mergers Evidence 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 Mergers Evidence 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	(10007913)	-10007913	-	-
Year 1	3452457	-6555456	3452457	0.8696	3002137
Year 2	3976328	-2579128	7428785	0.7561	3006675
Year 3	3962293	1383165	11391078	0.6575	2605272
Year 4	3231859	4615024	14622937	0.5718	1847826
TOTAL					10461910

The Net NPV after 4 years is 453997

(10461910 - 10007913 )

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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	(10007913)	-10007913	-	-
Year 1	3452457	-6555456	3452457	0.8333	2877048
Year 2	3976328	-2579128	7428785	0.6944	2761339
Year 3	3962293	1383165	11391078	0.5787	2292994
Year 4	3231859	4615024	14622937	0.4823	1558574
TOTAL					9489954

The Net NPV after 4 years is -517959

At 20% discount rate the NPV is negative (9489954 - 10007913 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Mergers Evidence 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 Mergers Evidence has a NPV value higher than Zero then finance managers at Mergers Evidence 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 Mergers Evidence, then the stock price of the Mergers Evidence 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 Mergers Evidence 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 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 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.

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 Mergers and People: Key Factors for an Effective Acquisition and for Surviving One

References & Further Readings

Guido Stein Martinez, Marta Cuadrado (2018), "Mergers and People: Key Factors for an Effective Acquisition and for Surviving One Harvard Business Review Case Study. Published by HBR Publications.