NPV of Venture Capital Project separate, required, expected, investment

pacmandefense

As a follow on here. I struggled with my baII on saturday with one of these q's! Seems silly but couldnt punch it out. In example above. I simply use CF0 -1mill , CF1-CF9 0 and CF10 as 20 mill. 1/y 15. N 10. didnt get correct answer....clearly manula calc is straighfoward buy For my education what have I done wrong? Il be review TVM tonight thats for sure!

FVPV

D James Wrote:
-------------------------------------------------------
> As a follow on here. I struggled with my baII on
> saturday with one of these q's! Seems silly but
> couldnt punch it out. In example above. I simply
> use CF0 -1mill , CF1-CF9 0 and CF10 as 20 mill.
> 1/y 15. N 10. didnt get correct answer....clearly
> manula calc is straighfoward buy For my education
> what have I done wrong? Il be review TVM tonight
> thats for sure!

That would be the calculation if the 25mil were guaranteed, but you need to discount the 20mil back to T0 and then weight it by it's probability of happening i.e. 80%, then subtract the risk weighted initial outlay 1mil*20%

EastCoastJ

The CFA book has 2 separate ways of calculating the NPV of a venture capital project (one in Example 5 on p. 217 and one in Practice Problem #9 on p. 247). I was wondering when to use each method.

For example, you have a project that requires a $1mm investment, 20% failure, 80% success (which will pay $25mm after 10 years), 15% cost of equity...

One method is to use the PV of the expected payoff minus the required initial investment (this method is used in PP#9):
20%*0 + 80%*(25mm/1.15^10) - 1mm

The other method is to use the weighted NPVs of each scenario (this method is used in Example 5):
20%*-1mm + 80%*(-1mm + 25mm/1.15^10)

Which one is correct?? Is this a mistake in the book?

Thanks so much.

Flok

1logic Wrote:
-------------------------------------------------------
> D James Wrote:
> --------------------------------------------------
> -----
> > As a follow on here. I struggled with my baII
> on
> > saturday with one of these q's! Seems silly but
> > couldnt punch it out. In example above. I
> simply
> > use CF0 -1mill , CF1-CF9 0 and CF10 as 20 mill.
> > 1/y 15. N 10. didnt get correct
> answer....clearly
> > manula calc is straighfoward buy For my
> education
> > what have I done wrong? Il be review TVM
> tonight
> > thats for sure!
>
> That would be the calculation if the 25mil were
> guaranteed, but you need to discount the 20mil
> back to T0 and then weight it by it's probability
> of happening i.e. 80%, then subtract the risk
> weighted initial outlay 1mil*20%

^^^ That didn't make sense, I usually make it a rule to risk weight Cash Flows at the same time period, but I guess you don't really have to. Intuitively I thought that 80% of the PV of 25mil wasn't the same as the PV of 20mil, but just checked and it is. So you could have just entered something in wrong, idk.