Voluntary Retirement Scheme, NPV and Monte Carlo Simulation

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Mergers and acquisitions (fact is it is always acquisition) keep happening, post acquisition number of initiatives happen ex. Defining vision and strategy, job evaluation, defining KRAs, team-building workshops etc. This also results in some employees becoming surplus- Noah’s ark- you have two of each species.

HR is given responsibility of handling these surplus employees (after all assumption is human problems are proprietary to HR). Some HR heads keep dragging feet, unable to face surplus employees who were till few days back their pals.

VRS is a good option for such employees. Many times HR head is unable to design or push scheme due inability/lack of confidence to face CEO and CFO. Because first question a CFO asks is does it make sense to keep employees on roll till retirement or is VRS cheaper (VRS entails huge cash outflow as it is one time payment). HR head goes into “human angle” theory, which makes no sense to CFO.

It will be easier to sell scheme if HR uses tools from finance and economics, as it is the language CFO understands.

From legal angle, any employee who is above age of 40 and completed 10 years of service in organization is eligible to apply. VRS amount is least of following amounts- 3 months of basic salary for every year worked or one month’s basic salary for balance months of service left (each company has its own version with cap on amount)

Once list of employees is identified, calculate amount payable if scheme were to be implemented. This is VRS option.

Now calculate other option i.e. outflow if we keep them on roll till age of superannuation. Calculate salary outflow for each year, till last person retires ( Monte Carlo Simulation is good technique to come to average increment Y-O-Y, as you can use random numbers within a specified range say increment of 5%-10% over a period of time). Now calculate net present value of this amount-NPV. If NPV of keeping employees on rolls is more than VRS option then go for VRS. Normally this will be the case, unless you have large chunk of employees nearing retirement.

Other requirement for NPV is discount rate, again use your excel sheet for Monte Carlo Simulation to come up with discount rate for NPV, which is usually your cost of capital.
There is nothing scientific about it, like HR, finance too works based on assumptions, but with Monte Carlo Simulation, assumptions look scientific ☺

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