Venture capital evaluation model using real options

Abstract

This study applies the real options approach to elucidate investment timing for venture capital companies. This analysis attempts to determine the optimal hitting time t* that makes the gross value of project at maturity time T of initial public offering. When this value discounted back to t* equals the expected variable cost invested at time t*. The venture capital company will then make a break even. Through numerical analysis, under situations of actual and expected discount rates, the optimal hitting time t* is shown as 1.58 years and 3.996 years, respectively. Project value is $0.51(million) and $2.02 (million), respectively. Furthermore, with an actual discount rate, determines that the function of optimal hitting time t* with speed of mean reversion a is monotonically decreasing. Conversely, with maturity time T , mean reversion level b and σ are monotonically increasing. By applying of expected discount rate, the function of optimal hitting time t* with σ , and speed of mean reversion a are both monotonically decreasing. Mean reversion level b is monotonically increasing with maturity time T .