Three Growth Options for Sanhinda Finance
Sanhinda Finance plc is a licensed finance company with LKR 96 billion of assets, 71 branches and a return on equity of 8.4% against a cost-to-income ratio of 66%. Its core product, gold-backed pawning, is shrinking as licensed commercial banks have entered with lower rates and faster turnaround. The board is weighing three options for the next three years. Option A: a digital, app-based lending subsidiary for urban salaried borrowers, needing LKR 2.4 billion of technology and marketing spend and an expected 18-month loss. Option B: acquire a smaller finance company with LKR 11 billion of assets, a branch footprint concentrated in the Eastern Province, and a deposit base priced 180 basis points below Sanhinda's. Option C: open 25 pawning kiosks inside supermarkets at LKR 45 million each. The Central Bank has flagged tighter scrutiny of unsecured retail credit quality. Sanhinda's Tier 1 ratio is 13.1% against an internal floor of 13.0%, and a single large IT write-off would breach it.
1. Evaluate the three options against suitability, acceptability and feasibility, and recommend a course of action with the conditions attached to it.
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Option C - kiosks (market penetration) Suitability: low. It adds distribution to a product that is declining because of price and turnaround, not because of access. Feasibility: high, LKR 45m per unit and fast payback. Acceptability: tolerable. It is the safe option that entrenches a weakening position.
Option A - digital lending subsidiary Suitability: builds a capability Sanhinda lacks, but it enters unsecured salaried lending precisely where the regulator has flagged asset-quality scrutiny, and where the company has no scorecard history for the segment. Acceptability: poor on the numbers - LKR 2.4 billion of spend, an 18-month loss and a Tier 1 ratio 10 basis points above the internal floor means the company cannot absorb an overrun. Feasibility: the binding constraint is credit data and collections capability, not the app.
Option B - acquisition Suitability: highest. The real strategic problem is structural cost of funds - a 180 basis point cheaper deposit base attacks the competitor advantage that has been eroding pawning, and cannot be built organically in reasonable time. Acceptability: capital-intensive through goodwill and the target's loan book, and the Tier 1 headroom must survive it. Feasibility: depends entirely on due diligence of the target's legacy asset quality and on integration of branch systems.
Recommendation Proceed with B as the core move, with C deployed only inside the acquired branch footprint as low-cost extension, and A reduced to a small, ring-fenced pilot rather than a subsidiary.
Conditions
- Independent loan-book due diligence with a repricing of the bid for any shortfall in provisions.
- A capital plan that keeps Tier 1 above 13.0% under a stress case, agreed with the board before signing.
- A 100-day integration plan with named owners for systems, credit policy and staff retention.
- A stage gate on the digital pilot: a defined scorecard performance threshold before any scale-up.
2. A board member argues the decision should simply be the option with the highest NPV and IRR. Explain why that ranking would mislead here and what appraisal discipline you would insist on.
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Why a single financial ranking fails
- The options are not mutually exclusive and not directly comparable. B changes the cost of funds available to C, so the pair is worth more than the sum of two standalone appraisals. Ranking them side by side discards that complementarity.
- Different risk profiles, one discount rate. A is a start-up venture with an 18-month loss and no track record; B is an acquisition with due-diligence risk concentrated in the loan book; C is near-certain cash flow. Discounting all three at one group WACC flatters A and penalises B.
- Terminal value dominates the arithmetic. For a three-year appraisal, most of the NPV sits in a terminal value that is chosen, not measured. Small changes in the assumed growth rate will reorder the options without any change in strategic merit.
- Regulatory capital is a real constraint missing from NPV. Tier 1 sits 10 basis points above the internal floor. Capital consumption per option, and the capital a stress scenario would demand, must be part of the decision; a higher-NPV option that breaches the floor is not available.
- Option value and reversibility are ignored. The digital pilot creates information about a segment at small cost; the acquisition is largely irreversible. NPV treats the ability to stop as worth nothing.
Appraisal discipline
- Screen on strategic fit first: does the option address the diagnosed problem - cost of funds and capability - or only add volume?
- Then risk-adjusted acceptability: scenario or stress test each option at a probability-weighted level, with a capital headroom test under the downside.
- Then feasibility: execution capacity, management attention, systems and regulatory approvals.
- Only then compare returns, using option-specific hurdle rates and an explicit terminal value sensitivity range.
- Treat the digital pilot as a real option, valued as a staged investment with a decision gate, not a full-commitment project.