ENTREPRENEURIAL FINANCE (FIN 512) WEEK 7 HOMEWORK 1

Week 7 Assignment

Michael Madrid

Keller Graduate School of Management

Finance 512: Entrepreneurial Finance

June 20, 2015

Entrepreneurial Finance (FIN 512) Week 7 Homework

Chapter 14: #1 and #3 (pgs. 523 – 524)

Question #1 a

To determine the value of the enterprise, it is necessary to compute first the operating value as follows:

According to Pignataro (2013), the formula for determining OP, Operating value;

OV =

Where EV = enterprise value of next year; WACC = Weighted Average Cost of Capital; and g = expected growth rate;

OV= = $5,200,000 / 0.09 = $57,777,777.78

Thus, the enterprise value = OV + surplus

Therefore, the enterprise value would be OV + surplus cash (IT Governance Institute, 2008)

Current EV = $57,777,777.78 + 4,000,000 = $61,777,777.78

Additionally, Equity Value, EQV = Total EV minus Interest less bearing debt;

EQV = $61,777,777.78 - $17,500,000 = $44,277,777.78

Question #1 b

Scrutinizing the given information, and determining the percentages using outstanding shares, the investors of the venture would own 60 % of business value while founders would have 40 % of equity

Looking at the equity value of the venture - $44,277,777,78 you can solve for each percentage.

For venture investors;

EV x 60% = $26,566,666.67

For founders;

EV x 40% = $17,711,111.11

Investors value/share = $26,566,666.67 / 3,000,000 = $ 8.86/ share

Founders value/share = $17,711,111.11 / 2,000,000 = $8.86/ share

(Venture Investors & Founders) value / share = $44,277, 777.78 / 5,000, 000 = $8.86 share.

Question #1 c

Current Stock Price- / $ 8.86
Initial Stock Price- / $ 2.50
Appreciation- / $6.36
Venture Investors Percentage- Appreciation- / 242.40%
Initial Stock Price- / $0.50
Current Stock Price- / $8.86
Appreciation- / $8.36
Founders Percentage Appreciation- / 1, 672.00%

Question #1 d

Founder Initial Investment- / $0.50
Number of Shares- / 2,000,000
Value- / $1,000,000.00
Current Value- / $17,711,111.11
Compound Rate of Return- / 77.68%
Venture Investor first round pass (shares)- / 1,500,000
Amount per share- / $2.00
Value- / $3,000,000.00
Value of original investment now- / 50%
Value- / $13,283,333.33
First Round Rate of Return- / 45.06%
Venture Investor second round pass (shares)- / 1,500,000
Amount per share- / $3.00
Value- / $4,500,000.00
Value of original investment now- / 50%
Value- / $13,283,333.33
Second Round Rate of Return- / 71.81%

Question #3

EASTTEK / SOUTHTEK / NORTHTEK
Net Sales- / $25,000,000.00 / $37,500,000.00 / $80,000,000.00
EBITDA- / $12,500,000.00 / $20,000,000.00 / $37,500,000.00
Net Income- / $2,500,000.00 / $3,000,000.00 / $10,000,000.00
Equity Value- / $45,000,000.00 / $60,000,000.00 / $160,000,000.00
Interest-bearing debt- / $15,000,000.00 / $20,000,000.00 / $40,000,000.00

Question #3 a

Enterprise Value, EV= Equity Value, EQV + interest Bearing Debt, I
Equity Value = Market Cap. (outstandingshares x stock price) (FouqueLangsam, 2013)
Equity Value / IDB / EV / Net Sales / EV / NS ratio
NorthTek / $160 / $40 / $200 / $80 / 2.5
EastTek / $45 / $15 / $60 / $25 / 2.4
SouthTek / $60 / $20 / $80 / $38 / 2.1
7.03
Competitors’ Average Ratio / 2.34

Question #3 b

Enterprise Value divide by EBITDA ratio / EV / EBITDA / EV / EBITDA ratio
NorthTek / $200.00 / $37.50 / 5.3
EastTek / $60.00 / $12.50 / 4.8
SouthTek / $80.00 / $20.00 / 4.0
14.1
Competitors’ Average Ratio / 4.71

Question #3 c

Equity Value divide by Net Income ratio / EV / Net Income / EV / NI ratio
NorthTek / $160.00 / $10.00 / 16
EastTek / $45.00 / $2.50 / 18
SouthTek / $60.00 / $3.00 / 20
54
Competitors’ Average Ratio / 18

Question #3 d

Enterprise Value Estimates: (high-to-low)

Enterprise Value Estimates / EV /( NS ratio) / Sales Multiple / EV Estimate
NorthTek / 2.5 / $21.20 / $53.00
EastTek / 2.4 / $21.20 / $50.88
Competitors’ Average ratio / 2.34 / $21.20 / $49.61
SouthTek / 2.1 / $21.20 / $44.52

Equity Value Estimates: (high-to-low)

Equity Value, EQV, Estimates / Enterprise Value / IBD / Equity Value Est.
NorthTek / $53.00 / $12.00 / $41.00
EastTek / $50.88 / $12.00 / $38.88
Competitors’ Average ratio / $49.61 / $12.00 / $37.61
SouthTek / $44.52 / $12.00 / $32.52

Question #3 e

Enterprise Value: (highest-to-lowest)

Enterprise Value, EV / EBITDA multiple / WestTek EBITDA / Enterprise Value
NorthTek / 5.3 / $11.10 / $58.83
EastTek / 4.8 / $11.10 / $53.28
Competitors’ Average Ratio / 4.71 / $11.10 / $52.28
SouthTek / 4 / $11.10 / $44.40

Equity Value: (highest-to-lowest)

Equity Value / Enterprise Value / IBD / Equity Value
NorthTek / $58.83 / $12.00 / $46.83
EastTek / $53.28 / $12.00 / $41.28
Competitors’ Average Ratio / $52.28 / $12.00 / $40.28
SouthTek / $44.40 / $12.00 / $32.40

Question #3 f

Equity Value Estimates / NI Multiple / WestTek NI / Equity Value Est.
SouthTek / 20 / $2.90 / $58.00
EastTek / 18 / $2.90 / $52.20
Competitors’ Average ratio / 18 / $2.90 / $52.20
NorthTek / 16 / $2.90 / $46.40

Question #3 g

$ - in millions / High / Low
Part D- / $41.00 / $32.52
Part E- / $46.83 / $32.40
Part F- / $58.00 / $46.40
Highest High- / $58.00
Lowest Low- / $32.52
Equity Value, EQV, based on average sales multiple – lowest / $ 37.61
Equity Value, EQV, based on average EBITDA multiple / $ 40.28
Equity Value, EQV, based on average Net Income multiple – highest / $52.20

Question #3 h

Selling price computed from the bottom-line multiple approach (net income) would generate the highest value or return for founders and investors (Correia, 2007).

References

Pignataro, P. (2013). Financial modeling and valuation: A practical guide to investment banking and private equity.

IT Governance Institute. (2008). Enterprise value: Governance of IT investments : getting started with value management. Rolling Meadows, Ill: IT Governance Institute.

Correia, C. (2007). Financial management. Cape Town: Juta.

Fouque, J.-P., & Langsam, J. A. (2013). Handbook on systemic risk. Cambridge: Cambridge University Press.