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1. VC VALUATION: SOUTHWEST VENTURES IS CONDIDERING...

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1. VC VALUATION: SOUTHWEST VENTURES IS CONDIDERING AN INVESTMENT IN AN AUSTIN, TEXAS-BASED START-UP FIRM CALLED CREED AND COMPANY. CREED AND COMPANY IS INVOLVED IN ORGANIC GARDENING AND HAS DEVELOPED A COMPLETE LINE OF ORGANIC PRODUCTS OFR SALE TO THE PUBLIC THAT RANGES FROM COMPOSTED SOILS TO ORGANIC PESTICIDES. THE COMPANY HAS BEEN AROUND FOR ALMOST 20 YEARS AND HAS DEVELOPED A VERY GOOD REPUTATION IN THE AUSTIN BUSINESS COMMUNITY, AS WELL AS WITH THE MANY ORGANIC GARDENERS WHO LIVE IN THE AREA. LAST YEAR, CREED GENERATED EARNINGS BEFORE INTEREST, TAXES, AND DEPRECIATION (EBITDA) OF $4MILLION. THE COMPANY NEEDS TO RAISE $5.8 MILLION TO FINANCE THE ACQUISITION OF A SIMILAR COMPANY CALLED ORGANIC AND MORE THAT OPERATES IN BOTH THE HOUSTON AND DALLAS MARKETS. THE ACQUISITION WOULD MAKE IT POSSIBLE FOR CREED TO MARKET ITS PRIVATE-LABEL PRODUCTS TO A MUCH BROADER CUSTOMER HASE IN THE MAJOR METROPOLITAN AREAS OF TEXAS. MOREOVER, ORGANIC ANDMORE EARNED EBITDA OF $1 MILLION IS 2009. THE OWNERS OF CREED VIEW THE ACQUISITION AND ITS FUNDING AS A CRITICAL ELEMENT OF THEIR BUSINESS STRATEGY, BUT THEY ARE CONCERNED ABOUT HOW MUCH OF THE COMPANY THEY WILL HAVE TO GIVE UP TO A VENTURE CAPITALIST IN ORDER TO RAISE THE NEEDED FUNDS. CREED HIRED AN EXPERIENCED FINANCIAL CONSULTANT, IN WHOM THEY HAVE A GREAT DEAL OF TRUST, TO EVALUATE THE PROSPECTS OF RAISING THE NEEDED FUNDS. THE CONSULTANT ESTIMATED THAT THE COMPANY WOULD BE VALUED AT A MULIPLE OF FIVE TIMES EBITDA IN FIVE YEARS AND THAT CREED WOLD FROW THE COMBINED EBITDAS OF THE TWO COMPANIES AT A RATE OF 20% PER YEAR OVER THER NEXT FIVE YEARS IF THE ACQUISITION OF ORGANIC ANDMORE IS COMPLETED. NEITHER CREED NOR ITS ACQUISITION TARGET, ORGANIC AND MORE, USES DEBT FINANCING AT PERSENT. HOWEVER, THE VC HAS OFFERED TO PROVIDE THE ACQUISITION FINANCING IN THE FROM OF CONVERTIBLE DEBT THAT PAYS INTEREST AT A RATE OF 8% PER YEAR AND IS DUE AND PAYABE IN FINE YEARS. A. WHAT ENTERPRISE VALUE DO YOU ESTIMATE FOR CREED (INCLUDING THE PLANNED ACQUISITION) IN FINE YEARS? B. IF THE VC OFFERES TO FINANCE THE NEEDED FUNDS USING CONVERTIBLE DEBT THAT PAYS 8% PER YEAR AND CONVERTS TO A SHARE OF THE COMPANY SUFFICIENT TO PROVIDE A 25% RATE OF RETURN ON HIS INVESTMENT OVER THE NEXT FIVE YEARS. HOW MUCH OF THE FIRM?S EQUITY WILL HE DEMAND? C. WHAT FRACTION OF THE OWNERSHIP IN CREED WOULD THE VENTURE CAPITALIST REQUIRE IF CREED IS ABLE TO GROW ITS EBITDA BY 30% PER YEAR (ALL ELSE REMAINING THE SAME) AND THE VENTURE CAPITALIST STILL REQUIRES A 25% RATE OF RETURN OVER THE NEXT FIVE YEARS? 2. VALUING GOLD RECLAIMED FROM OLD PERSONAL COMPUTERS: A NUMBER OF INDUSTRIAL PRODUCTS INCLUDE GOLD AND SILVER AS A COMPONENT BECAUSE THEY HAVE VERY GOOD CONDUCTIVE PROPERTIES. THE S&M SMELTING COMPANY ENGAGES IN THE RECONVERY OF GOLD FROM SUCH PRODUCTS AND IS CONSIDERING A CONTRACT TO BEGIN EXTRACTING THE GOLD FROM THE RECYCLING OF PERSONAL COMPUTERS. THE PROJECT INVOLVES CONTRACTING WITH THE STATE GOVERNMENTS OF THREE MIDWESTERN STATES TO DESPOSE OF THEIR PCS. THE PROJECT WILL LAST FOR FIVE YEARS, AND THE CONTRACT CALLS FRO THE DISPOSAL OF 200,000 PCS PER YEAR. THERE TONS OF ELECTRONIC SCRAP CONTAINS APPROXIMATELY ONE TROY OUNCE OF GOLD. MOREOVER, EACH PC CONTAINS APPROXIMATELY 6 POUNDS OF ELECTRONIC SCRAP, AND THE PROCESSING COST INVOLVED IN EXTRACTING THE GOLD IS $67.50 PER TON OF SCRAP. IN ADDITION, THE CURRENT SPOT PRICE OF GOLD IS $592.80, AND THE FORWARD PRICE CURVE FOR THE PRICE PER OUNCE OF GOLD SPANNING THE NEXT FICE YEARS IS AS FOLLOWS: 2011 $679.40/OUNCE 2012 $715.10/OUNCE 2013 $750.60/OUNCE 2014 $786.90/OUNCE 2015 $822.80/OUNCE S&M ESTIMATES THAT THE FIRM?S COST OF CAPITAL IS 10.5%, AND THE RISK FREE RATE OF INTEREST ON FIVE-YEAR TREASURY BONDS IS CURRENTLY 5.0%. IN ADDITION, S&M FACES A 30% TAX RATE, AND THE ENTIRE INVESTMENT OF $450,000 MADE IN THE PROJECT IN 2010 WILL BE DEPRECIATED USING STRAIGHT-LINE DEPRECIATION OVER FIVE YEARS WITH A ZERO SALVAGE VALUE. A. ESTIMATE THE AFTER-TAX (CERTAINTY-EQUIVALENT) PROJECT FREE CASH FLOWS FOR THE PROJECT OVER ITS FIVE-YEAR PRODUCTIVE LIFE. B. USING THE CERTAINTY-EQUIVALENT VALUATION METHODOLOGY, ESTIMATE THE NPV OF THE PROJECT. C. IF WE ASSUME THAT GOLD PROCES WILL INVREASE AT A RATE OF 7% PER YEAR OVER THE NEXT FIVE YEARS, WHAT IS THE NPV OF PROJECT USING THE TRADITIONAL WACC METHOD OF ANALYSIS BASED ON EXPECTED PROJECT FREE CASH FLOW, WHERE THE WACC IS ESTIMATED TO BE 10.5%? WHAT RATE OF GROWTH IN GOLD PRICES IS REQUIRED TO PRODUCE THE SAME NPV USING THE TRADITIONAL WASS APPROACH AS WITH THE CERTAINTY-EQUIVALENT APPROACH USED IN PART B? 3. Valuing an American option: J&V DRILLING COMPANY HAS RECENTLY ACQUIRED A LEASE TO DRILL FOR NATURAL GASS IN A REMOTE REFION OF SOUTHWEST LOUISIANA AND SOUTHEAST TEXAS. THE AREA HAS LONG BEEN KNOWN FOR OIL AND GAS PRODUCTION, AND THE COMPANY IS OPTIMISTIC ABOUT THE PROSPECTS OF THE LEASE. THE LEASE CONTRACT HAS A THREE-YEAR LIFE AND ALLOWS J&B TO BEGIN EXPLORATION AT ANY TIME UP UNTIL THE END OF THE THREE-YEAR RERM. J&B?S ENGINEERS HAVE ESTIMATED THE VALUE OF $25 MILLION ON IT, ON THE CONDITION THAT EXPLORATIONS BEGIN IMMEDIATELY. THE COST OF DEVELOPING THE PROPERTY IS ESTIMATED TO BE $23 MILLION (REGARDLESS OF WHEN THE PROPERTY IS DEVELOPED OVER THE NEXT THRE YEARS). BASED ON HISTORIAL VOLATILITIES IN THE RETURNS OF SIMILAR INVESTMENTS AND OTHER RELEVANT INFORMATION, J&B?S ANALYSTS HAVE ESTIMATED THAT THE VALUE OF THE INVESTMENT OPPORTUNITY WILL EVOLVE OVER THE NEXT THREE YEARS. THE RISK-FREE RATE OF INTEREST IS CURRENTLY 5%, AND THE RISK-NEUTRAL PROBABILITY OF AN UPTICK IN THE VALUE OF THE INESTMENT IS ESTIMATED TO BE 46.26%. A. EVALUATE THE VALUE OF THE LEASED AS AN AMERICAN CALL OPTION. WHAT IS THE LEASE WORTH TODAY? B. AS ONE OF J&B?S ANALYSTS, WHAT IS YOUR RECOMMENDATION AS TO WHEN THE COMPANY SHOULD BEGIN DRILLING? 4. SIMPLE INVESTMENT STRATEGY-STAGED INVESTMENTS: YOU HAVE BEEN RETANED TO EVALUATE A MAJOR INVESTMENT FOR A TECHNOLOGY COMPANY. THE COST OF THE PROJECT IS $100 MILLION. IF THE PROJECT IS SUCCESSFUL, IT WILL GENERATE EXPECTED PROFITS OF $15 MILLION PER YEAR FOREVER, WHICH HAS A PERSENT VALUE OF $150 MILLION. HOWEVER, THERE IS A 50% CHANGE THAT THE PROJECT WILL BE A COMPLETE FAILURE, IN WHICH CASE IT WILL GENERATE NO CASH FLOWS. MOREOVER, IF THE PROJECT IS SUCCESSFUL, THERE WILL BE A FOLLOW ONPROJECT THAT CAN BE INITIATED THE FOLLOWING YEAR. THE FOLLOW ON PROJECT WILL HAVE A COST OF $1 BILLION, AND IF THINGS GO WELL (PROBABILTITY OF 50%), IT WILL GENERATE EXPECTED CASH FLOWS OF $150 MILLION PER YEAR THAT LST FOREVER AND RESLT IN A VALUE OF $1.5 BILLION (IN YEAR 1 DOLLARS). IF THE FOLLOW ON PROJECT IS OT SUCCESSFUL, IT WILL RESULT IN A STREAM OF CAHS FLOWS WITH A PERSENT VALUE OF $900 MILLION. SHOULD THE INITIAL PROJECT BE TAKEN? EXPLAIN YOUR RECOMMENDATION IN COMMONSENSE TERMS TO YUR BOSS, WHO IS NOT A ?TECHIE.?,i'm still waiting for your response, thank you

 

Paper#5548 | Written in 18-Jul-2015

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