×




PureTech Ventures in 2011 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 PureTech Ventures in 2011 case study


At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. PureTech Ventures in 2011 case study is a Harvard Business School (HBR) case study written by Andrei Hagiu, Cesar Castro, Sarah Murphy. The PureTech Ventures in 2011 (referred as “Puretech Sheet” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Joint ventures.

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






Case Description of PureTech Ventures in 2011 Case Study


In early May 2011, Daphne Zohar, founder and managing partner of PureTech Ventures, a life science venture creation company in Boston, MA, was reviewing a term sheet she had just received from a venture capital (VC) firm for one of PureTech's portfolio companies. The term sheet was due to expire in a week, but through negotiations of term sheet items, PureTech could probably leave the discussions with the venture firm open for another month. PureTech had a unique position in the life sciences ecosystem. It aimed to tackle important medical needs by translating scientific innovations into commercially viable technologies, and in order to do that optimally, was structured as an operating company that created start-ups rather than a typical venture fund that simply invested in them. The VC term sheet Zohar was considering outlined a Series A funding round for one of PureTech's newly created companies. Meanwhile, Zohar's team was also in discussions with several large pharmaceutical companies that were interested in partnering or even acquiring the company. These discussions were progressing nicely but would not lead to a transaction by the due date set by the VC term sheet (or an additional month from then). The current situation presented her with a unique challenge. Should PureTech accept the "bird in hand" VC term sheet or turn it down and wait for the negotiations with the pharmaceutical companies to play out? The latter route offered the potential for a desirable, near-term partnership, but risked that the negotiations would fall through, in which case PureTech would end up losing both time and the opportunity for near-term external validation of its portfolio company.


Case Authors : Andrei Hagiu, Cesar Castro, Sarah Murphy

Topic : Finance & Accounting

Related Areas : Joint ventures




Calculating Net Present Value (NPV) at 6% for PureTech Ventures in 2011 Case Study


Years              Cash Flow     Net Cash Flow     Cumulative    
Cash Flow
Discount Rate
@ 6 %
Discounted
Cash Flows
Year 0 (10011246) -10011246 - -
Year 1 3466205 -6545041 3466205 0.9434 3270005
Year 2 3959117 -2585924 7425322 0.89 3523600
Year 3 3937686 1351762 11363008 0.8396 3306157
Year 4 3232580 4584342 14595588 0.7921 2560506
TOTAL 14595588 12660268




The Net Present Value at 6% discount rate is 2649022

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.




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

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. Timing of the expected cash flows – stockholders of Puretech Sheet have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.
2. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Puretech Sheet shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.






Formula and Steps to Calculate Net Present Value (NPV) of PureTech Ventures in 2011

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 Finance & Accounting 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 Puretech Sheet 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 Puretech Sheet 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 (10011246) -10011246 - -
Year 1 3466205 -6545041 3466205 0.8696 3014091
Year 2 3959117 -2585924 7425322 0.7561 2993661
Year 3 3937686 1351762 11363008 0.6575 2589092
Year 4 3232580 4584342 14595588 0.5718 1848238
TOTAL 10445083


The Net NPV after 4 years is 433837

(10445083 - 10011246 )








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 (10011246) -10011246 - -
Year 1 3466205 -6545041 3466205 0.8333 2888504
Year 2 3959117 -2585924 7425322 0.6944 2749387
Year 3 3937686 1351762 11363008 0.5787 2278753
Year 4 3232580 4584342 14595588 0.4823 1558922
TOTAL 9475566


The Net NPV after 4 years is -535680

At 20% discount rate the NPV is negative (9475566 - 10011246 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Puretech Sheet 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 Puretech Sheet has a NPV value higher than Zero then finance managers at Puretech Sheet 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 Puretech Sheet, then the stock price of the Puretech Sheet 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 Puretech Sheet 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 –

What will be a multi year spillover effect of various taxation regulations.

Understanding of risks involved in the project.

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.






Negotiation Strategy of PureTech Ventures in 2011

References & Further Readings

Andrei Hagiu, Cesar Castro, Sarah Murphy (2018), "PureTech Ventures in 2011 Harvard Business Review Case Study. Published by HBR Publications.


Adecoagro SA SWOT Analysis / TOWS Matrix

Consumer/Non-Cyclical , Crops


Wiscom Sys A SWOT Analysis / TOWS Matrix

Capital Goods , Construction Services


Mito Securities SWOT Analysis / TOWS Matrix

Financial , Investment Services


DCC SWOT Analysis / TOWS Matrix

Energy , Oil & Gas Operations


Bellway SWOT Analysis / TOWS Matrix

Capital Goods , Construction Services


Kansai Nerolac Paints SWOT Analysis / TOWS Matrix

Basic Materials , Chemical Manufacturing


Gilead SWOT Analysis / TOWS Matrix

Healthcare , Biotechnology & Drugs


Gaon SWOT Analysis / TOWS Matrix

Utilities , Water Utilities