Measuring venture capital fund performance Net Present Value

Measuring venture capital fund performance: Net Present Value Exercise 2 (Homework) - You consider to invest in a venture capital fund. In order to make sure that the investment is rational, you calculate the NPV of this fund. The conditional failure rates of the fund are 20% (year 1), 12% (year 2), 15% (year 3), 17% (year 4) and 14% (year 5). The investment sum is $5 million, the estimated payoff after 5 years is $20 million and your required return is 22%. Calculate the net present value of this investment and discuss the result.

Solution

Given the failure rates for 5 years are 20%, 12%, 15%, 17%, and 14% respectively.

Survival rate in five years = (1-0.2) (1-0.12) (1-0.15) (1-0.17) (1-0.14)

= 0.8 * 0.88 * 0.85 * 0.83 * 0.86

= 0.4272 = 42.72%

The investment fund is $5 million and the required return is 22% and the payoff after 5 years is $20 million.

NPV= - initial investment + (payoff / (1+r) ^ 5)

NPV= -$5000000 + ($20000000 / 1.22^5)  

= -$5000000 + ($20000000 / 2.7)

= -$5000000 + $ 7407407

NPV = $2407407

Therefore the NPV of the investment is $2407407 (positive) and the survival rate of the fund is 42.72%.