Question

A venture capital firm is considering investing in a company. Assume the discount rate is 20%.

a. The first four years, the VC firm would be paying into the company. The payments from the VC firm would equal $5 million a year (starting at the end of the year).
b. In return, the VC firm expects that it would receive payments equal to $10 million for the following four years (end of year 5 to the end of year 8).

Should the VC firm invest in this company?

O Yes
O No

Answer 1

Answer:

No

Explanation:

Year end       Cash Flows ($)   PVF @20%        Present Value($)

1                            (5)                     .8333                   (4.1665)

2                           (5)                      .6944                  (3.472)

3                           (5)                      .5787                  (2.893)

4                           (5)                      .4823                  (2.4115)

5                           10                      .4019                    4.019

6                           10                      .3349                   3.349

7                           10                       .2791                   2.791

8                           10                       .2326                  2.326

                                   Net Present Value (NPV)=  (0.458)

Here, PVF stands for present value discounting factor at 20% rate and cash flows in bracket depict cash outflows.

Since, the net present value is negative, the venture capital firm should not invest in this company