Case 052Early-stage valuationHard

Hridvik Devices, a cardiac monitor maker, has no revenue and two regulatory gates ahead. Value it today with a risk-adjusted NPV and say what drives the answer.

The situation

Hridvik Devices has built a wearable cardiac monitor. It needs Rs 30 crore to finish clinical trials over the next two years, Rs 15 crore a year, and the trials succeed 55% of the time. If they succeed, it spends Rs 20 crore on the approval process in years three and four, Rs 10 crore a year, and approval comes through 70% of the time.

If approved, the device earns Rs 120 crore a year of cash flow for eight years, years five to twelve. Cash flows arrive at each year end. The fund discounts at 25%.

Your task

What is Hridvik worth today on a risk-adjusted basis, and which input moves the value most?

Quick check

Roughly what share of the launch value survives the two gates?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Hridvik is worth about Rs 36.3 crore today. The launch cash flows are worth Rs 163.6 crore in today's money if certain, but only 38.5% survives the two gates, leaving Rs 63.0 crore. Take off Rs 21.6 crore of certain trial spending and Rs 5.07 crore of expected approval spending. The discount rate moves the value most; of the company's own risks, trial success does.

Step 1Why can you not just discount the launch cash flows?

Picture a student who must clear an entrance exam and then an interview to get a job paying Rs 12 lakh a year. Nobody values the offer at the full salary before the exam; they weigh it by the chance of clearing both. A risk-adjusted NPV multiplies each future cash flow by the chance of getting that far, and only then discounts it. Hridvik's trial spending is certain, the approval spending happens only if trials succeed, and the launch cash flows need both gates: 55% times 70%, which is 38.5%.

Hridvik reaches launch only if trials succeed, 55%, and approval follows, 70%, a cumulative 38.5% chance, so launch cash flows worth Rs 163.6 crore today if certain are worth Rs 63.0 crore risk-adjusted and Rs 36.3 crore after costs.

Step 2How do the numbers build, year by year?

Take each block of cash, discount it at 25%, and weight it by the chance it happens. The trial spending is certain, so it counts in full: Rs 15 crore in each of years one and two is worth Rs 21.6 crore today. The approval spending is Rs 9.22 crore today but only happens 55% of the time, so it counts as Rs 5.07 crore. Eight years of Rs 120 crore from year five are worth Rs 163.6 crore today, and 38.5% of that is Rs 63.0 crore.

Block, Rs crore	Years	PV at 25%	Probability	Risk-adjusted
Trial spending	1 and 2	(21.6)	100%	(21.6)
Approval spending	3 and 4	(9.22)	55%	(5.07)
Launch cash flow, Rs 120 a year	5 to 12	163.6	38.5%	63.0
Value today		132.8		36.3

Without the probabilities Hridvik would look worth Rs 132.8 crore; weighting each block by the chance it happens cuts that to Rs 36.3 crore, because the launch cash flows count at only 38.5%.

The relationship

\text{rNPV} = 0.55 \times 0.70 \times \sum_{t=5}^{12}\frac{120}{1.25^t} - \sum_{t=1}^{2}\frac{15}{1.25^t} - 0.55\sum_{t=3}^{4}\frac{10}{1.25^t}

0.55 x 0.70	chance of passing trials and then approval
120	yearly launch cash flow, Rs crore
15, 10	yearly trial and approval spending, Rs crore
1.25	one plus the 25% discount rate

What it says in wordsWeight every cash flow by the chance of reaching it, discount it, and add them up.

Step 3Which input moves the value most?

Flex each input across a sensible range and watch the value. The discount rate swings it most, from Rs 22.5 crore at 30% to Rs 56.7 crore at 20%, because the cash sits five to twelve years out. Of the company's own risks, trial success moves it most. Ten points on trial success is worth about Rs 10.5 crore, against Rs 9.0 crore for ten points on approval, because a trial success is multiplied by the 70% approval chance that follows, while an approval success is multiplied by only the 55% that came before.

Moving the discount rate between 30% and 20% swings Hridvik's value from Rs 22.5 crore to Rs 56.7 crore, wider than a ten point change in trial success, Rs 25.8 to 46.9 crore, or in approval odds.

Step 4Is 25% the right rate once the probabilities are already in?

This is the point to raise with the interviewer. A 25% venture rate already carries a premium for failure, so applying it on top of explicit trial and approval probabilities counts the same risk twice. Practitioners who use risk-adjusted NPV often discount at a rate closer to the cost of capital for a proven business. At 15%, the same model gives about Rs 87.4 crore. Say which convention you are using, and use one or the other, not both. The limitation is honest too: the 55% and 70% are the hardest numbers in the model to know, and a regulator's view of a novel device can differ from any historical base rate.

Where candidates lose it

The usual miss is discounting the launch cash flows and subtracting the costs, with no probabilities at all. That gives Rs 132.8 crore, more than three times the risk-adjusted answer, and tells the interviewer you have not priced the gates.

The second is weighting the approval spending at 100% or 38.5%. It is spent only if trials succeed, so it carries the 55% chance of reaching it, not the chance of the gate it pays for.

What the interviewer asks next

A partner offers Rs 20 crore for 40% of Hridvik. On these numbers, is that a fair price?
How would a third gate, a reimbursement decision at 80%, change the value?
Why might the fund want to stage its money around the trial readout rather than invest it all today?

Company names and figures are illustrative.

1The situation

2Your task