Kleiner-Perkins and Genentech: When Venture Capital Met Science 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 Kleiner-Perkins and Genentech: When Venture Capital Met Science case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Kleiner-Perkins and Genentech: When Venture Capital Met Science case study is a Harvard Business School (HBR) case study written by G. Felda Hardymon, Tom Nicholas. The Kleiner-Perkins and Genentech: When Venture Capital Met Science (referred as “Genentech Perkins” from here on) case study provides evaluation & decision scenario in field of Finance & Accounting. It also touches upon business topics such as - Value proposition, Innovation, Technology, Venture capital.

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

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Case Description of Kleiner-Perkins and Genentech: When Venture Capital Met Science Case Study

Genentech is a rare success story in the biotechnology industry. Hundreds of billions of dollars of venture capital have been invested without the expected transformational effects. Established in 1976, Genentech was to develop the new science of recombinant DNA into viable therapeutic products with mass market appeal, something that most scientists agreed was at least a decade away. The founders, Herbert Boyer and Robert Swanson had limited financial resources, so they turned to Tom Perkins, the co-founder of Kleiner-Perkins, for venture funding. Genentech developed through an effective union between scientific and venture investment mindsets. In 1980 an IPO valued Genentech at $300 million. In 2009 it was fully acquired by the Swiss-based healthcare company, Roche, for $47 billion. Roche had held a majority stake in the company since 1990.

Case Authors : G. Felda Hardymon, Tom Nicholas

Topic : Finance & Accounting

Related Areas : Innovation, Technology, Venture capital

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Calculating Net Present Value (NPV) at 6% for Kleiner-Perkins and Genentech: When Venture Capital Met Science Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10010311)	-10010311	-	-
Year 1	3463405	-6546906	3463405	0.9434	3267363
Year 2	3979154	-2567752	7442559	0.89	3541433
Year 3	3960943	1393191	11403502	0.8396	3325684
Year 4	3246394	4639585	14649896	0.7921	2571448
TOTAL			14649896		12705928

The Net Present Value at 6% discount rate is 2695617

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.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Net Present Value
2. Internal Rate of Return
3. Profitability Index
4. Payback Period

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

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Formula and Steps to Calculate Net Present Value (NPV) of Kleiner-Perkins and Genentech: When Venture Capital Met Science

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 Genentech Perkins 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 Genentech Perkins 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	(10010311)	-10010311	-	-
Year 1	3463405	-6546906	3463405	0.8696	3011657
Year 2	3979154	-2567752	7442559	0.7561	3008812
Year 3	3960943	1393191	11403502	0.6575	2604384
Year 4	3246394	4639585	14649896	0.5718	1856136
TOTAL					10480989

The Net NPV after 4 years is 470678

(10480989 - 10010311 )

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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	(10010311)	-10010311	-	-
Year 1	3463405	-6546906	3463405	0.8333	2886171
Year 2	3979154	-2567752	7442559	0.6944	2763301
Year 3	3960943	1393191	11403502	0.5787	2292212
Year 4	3246394	4639585	14649896	0.4823	1565584
TOTAL					9507268

The Net NPV after 4 years is -503043

At 20% discount rate the NPV is negative (9507268 - 10010311 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Genentech Perkins 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 Genentech Perkins has a NPV value higher than Zero then finance managers at Genentech Perkins 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 Genentech Perkins, then the stock price of the Genentech Perkins 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 Genentech Perkins 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 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.

Understanding of risks involved in the project.

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.

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

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.

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Negotiation Strategy of Kleiner-Perkins and Genentech: When Venture Capital Met Science

References & Further Readings

G. Felda Hardymon, Tom Nicholas (2018), "Kleiner-Perkins and Genentech: When Venture Capital Met Science Harvard Business Review Case Study. Published by HBR Publications.